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The result is that the nominal values of stocks do not reflect the reality of economic production. It is possible to increase the value of the shares of a given company without any real increase in production or profit achieved by that company; this was the case with Amazon, where its stock value exceeded $300 at a time when the company had not achieved any profits. Enron is another example, where the rising value of their stock was based on false information about fictitious profits.
These kind of financial activities, transactions and dealings create two faces for the economy: a real face linked to the economic growth and production which indicates the real strength of the economy. And an imaginary side, that reflects the image seen and observed by the local and global community. When the difference between the two sides is small, there does not appear to be a serious problem in the economy. When the difference, however, is vast as is the case now, in 1987 and in 1929 it is dangerous and may lead to devastating consequences for many years, as happened with the Asian Tiger economies in the late 1990’s.
The capitalist countries are aware of the magnitude of the problem, and its seriousness, and keep developing plans and alternatives to prevent or delay an inevitable devastating collapse, to mitigate the effects of the collapse, or to exit quickly in case a collapse happens. A good example of such plans is the recent bail out of the Bear Stern Bank, which almost collapsed after the drastic decline of its stock prices. (The most recent bailout of more than a trillion dollars in US and Europe occurred few months after this article was written).
The direct cause of a stock market collapse is the attempt made by some investors to transfer what they own from fictitious money to real money. As an example, let’s assume that the real money is 10% of the total virtual money. This means the amount that can be turned into real money, is no more than 10% of total capital, and the rest is equal to none. So when the owners of the shares notice that a major investor started selling his possessions (to convert them to real money), they panic and start selling their possessions hoping to cash in some real money before the collapse. Then a collapse takes place and brings everything to the foundation (real money).
Let’s work through the example more thoroughly. Assume that there are 1000 shares in a company. Also, assume that each share is worth $100. So the total stock value of the company is $100,000. For the sake of argument, assume that the real value of the company is $10,000. In other words, the real value of the company is 10% of the virtual value. Now assume that a major investor sells 50 stocks at $100 and cashes $5000. If the rest of the share holders start selling their shares hoping to get real money from the company, they will be able to get no more than $5000 at best, which translates into $5 per share. Now if one more person was able to sell 50 shares at say $50 and cashes $2500, then the rest of the crowd will have to share the remaining $2500 at $2.5 a share. Eventually when all $10,000 are gone, the share will go to zero. This is how the stock values of Enron and Martha Stewart companies collapsed.
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