That is precisely the problem. Share prices do not reflect the actual value of the underlying product, and as a consequence there is a tendency for wild mismatches which are by their very nature destabilising, at least in the long run.Amazeroth wrote:Share prices don't tell you what a business is worth in fundamental terms, but just how much other people would be ready to pay for a share.
It seems like you've just established a false dichotomy here. Of course normal prices reflect how much people are prepared to pay, but that is not mutually exclusive with a reflection of the fundamental value (i.e. how much net utility the consumption of that product will bring). In financial markets, the speculative motive predominates. (Look at commodity traders - they don't give a crap how much net utility consuming coffee will bring them because they're not looking to consume coffee; they just want to sell it on for a higher price.) And this does create instability.Amazeroth wrote:Just as normal prices do.
The problem with financial market is that they tend to exacerbate human error. Once enough 'stupid people', as you call them, make the same error in buying a bad product, it creates a feedback loop which drives the prices higher. Which makes the product more attractive, and more importantly, it now becomes rational to purchase that product if you expect the price to rise further. The same goes when the price is plunging and everyone is panicking.Amazeroth wrote:But unless your point is that a system, in order to be good, or rational, must be so perfect that human error or irrationality can't occur, this is not really an indication whether the financial markets are a good system.
This would not happen in a normal product market. If people get irrationally exuberant about apples, they will not buy more apples in the hope that the price will rise so they can sell it on. They want to eat it. They will only purchase as much as they want to eat. And if a few people make misjudgments, the price mechanism will iron them out. In that sense, the financial system is especially susceptible to the effects of human failure. It aggregates failure, instead of mitigating it.
So I guess what I am trying to say is that the financial system is flawed not because it is imperfect - every system is imperfect - but because it is relatively more imperfect than normal markets, which are, in most circumstances (externalities etc. notwithstanding, and they can be dealt with quite easily) close enough to rational.
Of course some people will lose out in financial markets. That's absolutely normal. The reason that we should be especially concerned about the behaviour of financial markets is that they have systemic significance. If some random person loses his business, that's sad but at the end of the day few people outside his employees and family will feel the effects. If on the other hand a major bank - Lehman Brothers, for say - goes bust, then we have serious issues. It is absolutely necessary for creative destruction to take place to have a proper economy, but I think that financial markets, as always, are unique.Amazeroth wrote:I don't think that there's a difficulty because there is no way to stop shit happening - as long as the people who suffer from this had the option to inform themselves and of knowing that there was a risk to their investing, I don't think it could be said that the system is working the wrong way.