Stock exchage securities; an essay on the general causes of fluctuations in their price

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Chapter I. Introductory

There is a great deal in theoretical books of Political Economy on the genera] question of supply and demand as regulators of price, and what is meant by the tendency or alleged ten¬ dency of the one to equal the other. In the following pages I propose as much as possible to keep clear of this discussion, which tends to degenerate into a mere logomachy. There is no doubt that in most markets, and as regards most articles within very wide limits, an excess of demand over the supply at a given price will raise the price, and an excess of supply will lower it. As regards articles also which are capable of being produced in variable quantities, a high price will bring out an increase of supply, and a low price will check it. For some purposes it appears

B unnecessary to define the meaning of supply and demand more exactly ; and the questions regarding price, and supply and demand as con¬ nected with price, which seem most to require discussion, relate to the nature of the influences which govern the motives of individuals in supplying and demanding particular articles or groups of articles, and so make it possible to trace a certain order in the variations of the prices of such articles.

That there is such an order in regard to one large group of articles — what are known as securities of the Stock Exchange — it will be a principal object of this Essay to show. An attempt will also he made to give some account of what this order is, and to demonstrate the necessary relations between the prices of this group and the prices of other articles, including the hire of money.

It will be convenient to explain at the outset what is meant by securities of the Stock Ex¬ change. The word c security ’ is a very general one. In the language of the money market, it means the title of almost any kind of property which can be given as ‘ security ' for a loan. A bill of exchange, a dock-warrant, the titles of

INTRODUCTORY.

land or houses, mortgage deeds, may all be made use of, and are made use of, as securities for money lent. But the securities quoted on the Stock Exchange have certain peculiarities which are not the property of everything which may be a security for money. Their characteristic seems to be the combination of interest-bearing power, either actual, probable, or only potential and contingent, with the division of the article dealt in into equal parts, so as to be capable of exact definition and of being submitted to the speculative manipulation of a great market. It is obvious that other securities possess one or more of these features. Lands and houses, mort¬ gages, bills of exchange, shares in private part¬ nerships, capital employed by individuals singly in business, have an interest-bearing power of the same nature as the shares of joint-stock com¬ panies, or the debts of states, which are dealt in on the Stock Exchange. There are also articles capable of easy definition but without interest-bearing power, such as gold, corn, cotton, copper, pig-iron of certain brands, coffee, and probably others, which are all susceptible of being manipulated in a great market where there are crowds of dealers of various descriptions. But the combination of interest-bearing power with the facility of being handled like gold or cotton makes a Stock Exchange article a thing sui generis , whose fluctuations in price will conform to an order of their own which can be traced,

' although in doing so it will of course be necessary to bring out much that is common to them with other articles.

These definitions appear also to involve by implication what the nature of the inquiry must be. In distinguishing a great group of articles,

* and inquiring as to the laws of their price, wdiat we really inquire into is not merely the nominal money price of the articles, but the relation of their price to that of all others which are the subject of exchange, as well as the money which is the medium of the exchange. We must not think in such matters exclusively of the money price. What goes on at every exchange is that people sell corn, cotton, or other articles for money only in the first instance • the whole object of the sale is to enable them to purchase something else, and if purchases as a rule did not balance sales, apart from money, the whole machinery of business would come to a dead stop. If actual cash passed for all the articles

INTRODUCTORY.

sold in a country on a given day, it would not take many days for the whole cash of the country to be in the hands of a few sellers, so that the rest of the people would have no money to work with. The exchange for money, therefore, only covers a real exchange which is always going on between the articles which the money from time to time represents. What we may call the ultimate transactions in money, that is, transac¬ tions in which money in its narrowest sense is actually acquired and kept in the form of coin or bullion, are comparatively few, although such transactions are, no doubt, specially important in all questions of price.

The great groups of articles for which Stock Exchange articles are exchangeable may also be simply described. Particular securities must either be sold for other securities of the Stock Exchange ; or in exchange for interest-bearing securities which are not quoted on the Stock Exchange ; or in exchange for other articles, that is, for consumable commodities generally, using the latter word in its widest sense, so as to include such articles as diamonds and valuable pictures which seem little destructible, and also certain articles like corn, cotton, or gold, which

STOCK EXCHANGE SECURITIES.

are capable of being manipulated in a speculative market, but have not the property of bearing interest.

What are the laws of price then which affect the special article we have defined ?

Chapter II. The Connexion Between Prices And Tpie Quantity Of Money

It is laid down by writers on political economy and currency, though the practical application of the rule must be attended with difficulties, that the quantity of money in a country regulates the aggregate price of all articles. A hundred thou¬ sand pounds of gold will theoretically serve for the exchanges of a country as well as a million or ten million pounds. The nominal prices will be different, but the smaller nominal sum in one case will be as effective as the larger nominal sum in the other. The rule is correct of course only within certain conditions. To give it validity, it must be assumed that a scarcity of money produces no expedients for economising money, and that an abundance of money does not lead to want of economy, which can hardly ever be the actual conditions of life. It must

THE QUANTITY OF MONEY AND PRICES.

also be assumed that the quantity of commodities to be exchanged remains constantly the same, that the motive power of money is equal at all times, and that exchanges are effected at an unvarying rate of frequency, though in point of fact as we shall see the greatest changes in these respects are constantly taking place. But allow¬ ing all the conditions in which the rule applies to be fulfilled, we should still have to reckon as causes of change of prices generally the varia¬ tions in the quantity of money in a country. An addition to the circulation raises all prices, a deduction from it lowers them. But this change is only nominal ; the real prices are all the while unchanged. The same quantity of labour ex¬ changes for the same quantity of corn that it did before, or the same quantity of corn exchanges for the same Stock Exchange security, and matters are equalised. As we have said, it is most dif¬ ficult to show this rule, because the economies of money, the quantities of commodities, and credit, are daily changing things, but the theory in the abstract is a mere mathematical expression, and can hardly be disputed.

It follows then — the quantity of money in a country and its effectiveness and the quantity of

THE QUANTITY OF MONEY AND PRICES.

commodities for exchange remaining unaltered — that if there is a general fall in money price in one group of articles, this means a rise in money price in all the other groups. And a general rise in one group means an average fall in all the others. If this were not so, a certain part of the money in the country would in the one case be thrown out of circulation, which is contrary to the hypothesis, or a certain quantity of money would be added, which is also opposed to the hypothesis.

And such changes of money price would on the hypothesis also correspond to real changes in the relation between two groups of articles. Say it is a fall in the money price of securities ; this would mean that securities command a smaller quantity of other articles than they did before. On the other hand, a rise in the money price of securities would mean a greater command over other articles given to the holder of securities. The difference would also count both ways. In the first case supposed, that of a fall in securities, there must be, on the assumption made, a rise in the money price of other articles as well ; in the second case there is not only a rise in securities, but a fall in the money price of other articles*

The real changes in the relations of the two groups of articles are not measured merely by the change in the money price of one, but by the sum of the opposite changes in the money price of the two.

Of course it is quite obvious that in the real world the hypothetical change in the relations of two groups of articles here described can hardly ever be traced. As already mentioned, neither does the quantity of articles to be ex¬ changed, nor the amount of money in circulation, nor the state of credit on which depends the effectiveness of money, ever remain for two days the same. The rule, however, must be laid down as descriptive of a condition underlying the phe¬ nomena of the markets, and which will always be more or less operative.

Several corollaries from this principle are likely to be of practical importance. A change in any one of the conditions stated will have a great influence both on the aggregate price of securities and other articles which we may shortly term commodities, and on the relations of the two groups to each other. Thus an increase of the quantity of consumable commodities or of secu¬ rities will have the same effect on the markets

THE QUANTITY OF MONEY AND PRICES.

as a diminution of the quantity of money in circulation, unless there are simultaneous changes in the state of credit, or economies in the use of money, making the existing quantity more effective ; such an increase of the goods offering for exchange must alter the money level of price. It is possible that the alteration will at first be confined almost exclusively to the group of articles which is increased. The whole fall in the average level of price will be due to a special fall in the group, which will alter its relation to the other groups very materially. But this does not follow necessarily, and it does not follow that permanently the change will be confined to the group in which the increase of quantity takes place. All that can be affirmed as mathematically certain on the hypothesis assumed is, that an increase of securities or com¬ modities, like a diminution in the quantity of money, will cause a general fall of prices ; and a diminution of articles, like an addition to the quantity of money, a general risev

In the same way a variation in the frequency * of exchanges at different times will have an effect on prices which need not be particularly explained. More frequent exchanges, unless

THE QUANTITY OF MONEY AND PRICES.

other circumstances interfere, will require more money to maintain the former level of price, and less frequent exchanges will require less money.

It is another corollary of the principle that if there are natural limits to the quantities of com¬ modities or securities which can he produced, and limits also to the changes in the amount and effectiveness of money, and the frequency or infrequency of exchanges, then there will also he natural limits to the rises or falls in prices which are possible. An indefinite general rise or an indefinite general fall will be an impossibility. As the natural limits on either side are ap¬ proached, a movement of price which may have seemed uncontrollable will be checked. Whether there are such limits or not, and what they are, will be one of our inquiries. It will also follow from these principles, that any great change in the price of a particular kind of commodity or species of security implies a disturbance of rela¬ tions among securities and commodities in general ; and this circumstance, according to the known qualities of human nature, will itself contribute to make it unlikely that the change will be of a permanent kind, unless there is some substantial

THE QUANTITY OF MONEY AND PRICES.

change in the motives for the purchase or sale of the article. There must always be continual changes in the estimation in which particular articles are being held by mankind, but the presumption is against violent changes being enduring.

Another point of practical importance to attend to in consequence of the rule laid down will be, that in looking at a general rise or fall in prices, due to a change in the quantities of articles or money, or in the effectiveness of money, we must never overlook the nature of the real changes which this general rise or fall may con¬ ceal. Unless everything rises or fails proportion¬ ately in its money price, there will be an incessant real change in the relations of all articles to each other. If securities fall more than commodities, this will mean a general rise in commodities ; and if commodities fall most, this will mean a real rise in securities. If most commodities and most securities fall, this may mean an important real rise in the exchangeable value of those which remain stationary. It is unnecessary, however, to follow out in detail the points to be thus attended to in consequence of the differences between real price and money price.

Chapter III. The Causes Of Value In Securities, In Relation To Commodities

Having described in the previous chapter the abstract theory of the price of securities, and the meaning of a rise or fall, we have now to inquire as to the conditions under which the theory practically operates, and what are the main causes of a general rise or fall in price to be attended to.

We begin with the most general causes which can affect the value of securities. In a com¬ munity where there is an economic equilibrium, where production and consumption balance each other, where the investment of fixed capital pro¬ ceeds pari passu with the increase of population, and where the quantity of money in circulation increases only in proportion to the business done, it is quite clear that an adjustment of some sort will have been effected between the price of

THE CAUSES OF VALUE IN SECURITIES.

securities and that of other commodities. Apart from the changes due to the varying state of credit and other transitory causes, a community in such a state will insensibly have settled down into the acceptance of certain notions which will fix the relative desirability of certain articles and their relations one to the other through the mechanism of exchange. For our present purpose this means that a certain average rate of interest on capital will be accepted, and this will govern the price of securities by which the yield on the capital invested in them to the actual holders of that capital is regulated. If the yield is judged so low by holders of securities that the former rate of saving is checked, or if it is judged so high by the owners of consumable commodities, or the labourers and capitalists who can create them, that there is a constant bounty on the further saving and investment of capital, so far there will be no equilibrium, but conditions will exist which will cause changes in the relative prices of both securities and commodities.

It is, perhaps, hardly necessary to inquire what are the causes which determine a* community at a given period to accept a certain average yield on its capital. It is quite clear that in this respect there is a constant play of opposite motives. A high average yield on capital is a bounty on saving, and a low yield will to a certain extent check saving. Whether it is true, as some hold, that there is in modern communities as actually constituted, a tendency of profits to a minimum which would be a tendency to an almost indefinite rise in the price of securities, it is, perhaps, almost unnecessary for the present to discuss. All we point out now is, that this quality of interest-bearing will be valued in a certain way in a community in equilibrium, and that this is what is meant by the price of the securities of that community.

We must notice, however, that this quality of interest-bearing is necessarily not the only cause of variation in price amongst securities themselves, and that the rate of yield is not everything, even as regards the relation of securities to other commodities. As all know,

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the prices of securities relatively to each other vary much, and they are likely, as human nature is constituted, to vary much. Some are in larger bulk, and for that or for other reasons are more marketable. The vield of some is better secured, or thought to be better secured, than others.

THE CAUSES OF VALUE IN SECURITIES.

These are all causes for indefinite variations in the prices of individual securities. To a certain extent also the qualities of the securities which a community possesses will affect the rate of yield at which the price will be adjusted. If a com¬ munity is itself unstable, and capital more or less insecure, the adjustment will probably be made at a higher rate of yield than if the com¬ munity were stable and capital well protected. The bounty on saving and investment will require to be stronger in one case than in the other, and at a point it may cease to operate.

It is also noticeable that there will probably be a certain relation between the current rate of yield on fixed investments and the rate for money lent, principally the rate of discount on bills of exchange and the rates for short loans. In both cases the object aimed at is a certain yield for capital, and if makes no substantial difference that this is effected in the one case by the pur¬ chase of a title to property, and in the other by • a loan which is to be repaid. In buying, an investor or capitalist provides or ought to provide a sinking fund against depreciation, in case he should have to sell at a capital loss; and in lending, c he also insures in various ways against a loss of capital ; the provision for the sinking fund or insurance in both cases affecting the net yield. What the exact relation will be between the yield on fixed investments and that on floating capital or money lent will depend on many cir¬ cumstances — on the amount of money which it may be the custom to keep floating, for instance — but a relation of some sort must exist, which will tend to be re-established if it is disturbed from any cause.

The nature of this relation can, however, only be perceived when long periods of time are taken into account. It must not be supposed that every sudden change in the hire of money in the short loan market will be accompanied by corresponding changes in the price of securities. There is a close connexion indeed between the short loan market and the speculation in securities. The funds of the short loan market are employed partly in holding securities, and where these funds are diminished or increased from any cause, however temporary, there is an immediate effect on the price of some securities. But the great mass of securities will only be affected by more permanent changes in the rates obtainable for money in other

THE CAUSES OF VALUE IN SECURITIES.

markets, and it is of this more permanent relation we have here been speaking.

Applying these rules to the most general causes of the disturbance of economic equilibrium in a community as far as securities are concerned, viz., the increase of consumable commodities on the one hand, and the increase of securities on the other, we have to affirm that an increase of consumable commodities, where the rate of yield on capital is not at the minimum, will lead to a real rise in the price of securities, i.e., to a fall in the yield. That such an increase will cause a money fall in all articles on the average (the amount of money and its effectiveness being unchanged), has already been noticed ; but it would also seem certain that ordinarily it will cause the greatest fall in the kind of articles increased, i.e., consumable commodities. Unless there is simultaneously a total change in the estimation of securities as related to commodities, the increased offer of commodities will in fact mean that the owners are willing to exchange them for a smaller mass of securities than they did before. The result will also be a stimulus to the creation of securities. The desire for saving arises instantly the profit is made, and those who make the saving having either money or money’s worth in their possession, seek an investment for it. The equilibrium is accordingly disturbed. The holders of fixed capital have no motive to part with it, for the necessity for reinvestment would be immediately felt. The money or money’s worth, therefore, goes abegging, the holders constantly offering to buy for a smaller and smaller vield, until in the end the yield is so small that they no longer offer, or some one pays labourers to make something which it is hoped will yield an interest to tempt them. The only limits to the rise in securities, besides the natural one of the command over commodities given to the holders becoming excessive, are the inclination of the holders of commodities to keep in kind or spend rather than invest, and the creation of new securities, which means in fact the absorption of a portion of the capital which is seeking investment.

In the actual world, should there be a change in the amount of money or its effectiveness at the same time that there is capital seeking invest¬ ment, the apparent money rise in securities may be even greater than the real rise, or it may be less than the real rise, but the real change in

THE CAUSES OF VALUE IN SECURITIES.

the relation between securities and other articles will be what we describe.

The opposite contingency of an excessive creation of securities, causing a fall in them in relation to commodities, seems at first sight impossible. You cannot make new investments without actually using up new commodities. Confusion may be caused by engagements to invest beyond the savings of a community, but the investments themselves cannot be made. To a certain extent, however, it would seem that

A

they can be made. Unawares, a portion of the means of a community required for consumption may be diverted to fixed investments. To restore the equilibrium, it becomes necessary to create more consumable articles than formerly in a given time ; and while this is being done a certain portion of the invested capital gets to be on offer for the purpose of obtaining articles of consump¬ tion. In other words, securities fall through the excessive multiplication of them, and the dis¬ proportion thus brought about between them and consumable commodities. Should there be a decrease of money or its effectiveness at the same time, the fall in money price wall be marked, as well as the fall in the price of commodities ;

THE CAUSES OF VALUE IN SECURITIES.

but the money fall will also conceal a real fall in securities in relation to commodities.

As regards Stock Exchange securities in particular, it must further be noticed that the increase or decrease of consumable commodities seeking investment which can affect their price, must be an increase or decrease in what is offered in the general markets. If people who have a surplus of such commodities use them in extend¬ ing, say, their business premises, or in some other private manner, or finding a deficiency stop their current rate of outlay in fixed works, securities dealt in on the Stock Exchan ge cannot be affected. It is only therefore the general surpluses or deficiencies which are in question, and these, it is believed, are often much smaller than would be supposed beforehand. The most natural desti¬ nation of savings is in their private conversion into fixed capital under the control of their owners. New houses are built, or old houses extended and enlarged ; business premises are enlarged or improved, or better equipment pro¬ vided ; perhaps a new business of an analogous kind is set on foot ; perhaps additional floating capital is employed in the business, so that it may be conducted with ease and facility. It is

THE CAUSES OF VALUE IN SECURITIES.

only in comparatively small quantities, if we think of it, that savings are available for the creation of new securities of the kind quoted on the Stock Exchange, or that such securities are sold on balance for the purpose of obtaining commodities to be consumed ; were it otherwise, the real disturbance in the relations between securities and commodities would be incessant and tremendous. If a small amount of com¬ modities offering in excess must cause a consider¬ able rise in securities, and a small amount of securities on offer in excess a considerable fall, it is plainly most unlikely that the excesses are at any time very great. The changes great excesses would produce would immediately pro¬ duce reaction.

As business is now conducted, also there would seem a further condition to the applica¬ bility of an excess of commodities, other than money in its narrowest sense, in raising the price of securities generally. This is, that transactions must take place in them, so that they can be represented by deposits in a bank, against wdiich cheques can be drawn. So long as they are in the possession of the people who create them, or who have bought them without requiring to

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borrow for the purpose, they are not in the form of money, into which they must be converted before they can be exchanged for securities in a general market. But how are they to be con¬ verted into money ? To this the answer must be, that the holders must either sell them to some one for money, coin, or for a cheque upon a bank by a purchaser, which that purchaser, ex hypothesi , can only have the means of drawing by pre¬ viously borrowing from a bank, or the owner must himself pledge his excess of commodities with a banker, so that he can buy securities with the money so placed at his command. This is a plain deduction from the nature of the business of banks, the deposits in which must always be re¬ presented either by actual cash, or by re-deposits in other banks, or by loans or investments. These deposits can only be increased by an actual in¬ crease of cash, or by a loan upon credit, the amount of which is directly or indirectly re¬ deposited. Hence wre affirm that an excess of commodities likely to affect the general markets for securities must become the subject of an operation by which its value can be drawn against ; some one, in fact, must borrow upon it, so that the deposits in the banks may be increased. We shall see afterwards in what various ways the deposits in the banks may vary accord¬ ing to the state of credit, and how all-important this is in the question of the price of securities ; but we only call attention to the one fact at present, that an excess of commodities offering for investment which appears to be, and which probably is, a very potent natural influence in raising the price of securities, can itself only become operative by an increase of cash in the hands of the public or at the banks, or by a credit operation at the banks. In other words, the condition of savings affecting the markets for investments is itself probably a change in the state of credit which permits an increase of borrowing, so as also to permit an increase in the quantity of commodities held.

In the same way a diminution of commodities likely to affect markets for securities must be such a diminution as produces a diminution of the deposits — the surplus money — in banks. A destruction by fire of commodities appropriated privately for consumption where the loss is wholly borne by the immediate sufferers would have no appreciable effect in lowering the price of securities. The commodities consumed were not an offer in the general markets, and the loss is gradually made good by the privation of the people affected. But if the destruction is of an article on which a bank had made advances, the deposits in the bank are, somehow or other, reduced by an equivalent sum. When the advance falls due, it is either not repaid and has to be written off, or it is repaid out of other funds which the borrower from the bank possessed, whose deposits are pro tanto reduced. The money offering in the general markets is accordingly less than it was, and the force to support prices at the former level is weakened.