Why Are Stock Prices so Volatile?

“Since David Ricardo’s Principles there has been no book… which has exercised such great influence on the development of economics as Carl Menger’s Grundsätze [Principles].”

–Knut Wicksell

At the invitation of Jan Fijor, a publisher of free-market books in Warsaw, Poland, I just completed writing an introduction to the Polish edition of Carl Menger’s “Grundsätze,” translated “Principles of Economics” in English. I follow in the footsteps of introductions in previous editions by the iconoclastic Chicago economist, Frank Knight, and the Austrian economist Friedrich Hayek.

Carl Menger (1840-1921) was the founder of the Austrian school of economics when he published his “Grundsätze der Volkswirtschaftslehre” in 1871 and ushered in the “marginalist” revolution in economics. This is the idea that prices are determined by a marginal number of buyers and sellers, not the cost of production or labor inputs.

There’s no better example of this marginalist principle than in the stock market. In fact, not surprisingly, Menger discovered this concept when he was a reporter on the Vienna stock exchange. He observed that security prices were determined by a marginal (small) number of buyers and sellers, and therefore had nothing to do with their cost of production, or even book value, as the classical economists had claimed.

For example, last July, Yahoo, a high technology company, missed estimated per-share earnings by one penny, and the stock suddenly fell 8% in a day. That penny-per-share miss was bad enough for shareholders to dump their shares and cause the stock price of Yahoo to plummet. Nearly 80 million shares traded in one day — and yet that represented less than 5% of the outstanding Yahoo shares (1.2 billion).

Virtually no change took place in the day-to-day activities of the company and its employees. And yet a marginal number of shareholders caused the stock to collapse.

It reminds me of a book I wrote several years ago, “Investing in One Lesson.” The lesson is clear: “Wall Street exaggerates everything: The business of investing is not the same as investing in a business.”

Always remember: all prices of stocks, bonds, gold and real estate are determined by a small number of traders, and they can dramatically alter the price at any time. That’s the marginal principle.

You think Bill Gates is the wealthiest man in the world, worth $80 billion? That figure is based on the market value of the 400 million shares in Microsoft he owns at $32 a share. But what would happen to the price of those shares if Gates decided to unload 50 million shares? I guarantee you the price would plummet as he tried to sell, and word got around. He has to do it prudently and gradually to keep the value high.

Want to know more about Carl Menger and the Austrian way of investing? Get a copy of my new book, “A Viennese Waltz Down Wall Street: Austrian Economics for Investors,” available by calling Eagle Publishing, 1-800/221-7661. To order the 256-page book for only $19, plus $5 for shipping and handling, mention code WALTZ.

You Blew It! Labor Board Outlaws Courtesy

Can you believe this? The government labor board has ruled that BMW’s “courtesy to customers” rule is a violation of employees’ rights (and yes, apparently it’s okay for employees to use profanity and foul language).

Last year, on Sept. 28, the National Labor Relations Board (NLRB) ruled on Knauz BMW, Chicago BMW dealer, that its employer’s Employee Handbook violates employees’ rights. The handbook states:

Courtesy is the responsibility of every employee. Everyone is expected to be courteous, polite and friendly to our customers, vendors and suppliers, as well as to their fellow employees. No one should be disrespectful or use profanity or any other language which injures the image or reputation of the Dealership.

Thus, the NLRB has now ruled that requiring courtesy is unlawful. The theory is that requiring courtesy is a violation of employees’ rights under section 7 of the National Labor Relations Act (NLRA) which protects “concerted activities for the purpose of collective bargaining or other mutual aid or protection.” According to the NLRB, “Employees would reasonably construe its broad prohibition against disrespectful conduct and language which injures the image or reputation of the Dealership as encompassing Section 7 activity.”

Please click here to read the Knauz BMW Board Decision on Courtesy Requirements.

What is this country coming to?

To read my e-letter from last week, please click here. I also invite you to comment about my column in the space provided below.

Upcoming Appearances

This weekend, C-SPAN BookTV (www.booktv.org) is interviewing more authors who spoke at FreedomFest, including Raj Sisodia, co-author with John Mackey of “Conscious Capitalism.” I am being interviewed at 1 pm Eastern on Sunday, Aug. 11, and at 1 am Eastern Monday morning, Aug. 12, on my new book “A Viennese Waltz Down Wall Street.”

San Francisco Money Show, Aug. 15-17, San Francisco Marriott Marquis: Next week, join me and all the other Eagle editors (Doug Fabian, Nicholas Vardy and Chris Versace), plus William O’Neil (founder of Investor’s Business Daily), Frank Trotter (Everbank), Matt Schifrin (Forbes), John Bollinger, Chuck Butler and many others. There is no charge for this conference, but you do need to register. Call 1-800-970-4355, and mention code #031733.