The Role of the Stock Exchange in the Economy

by Gail Cohen

    You may be surprised to discover the number of stock markets blanketing the globe. Even a country not known for having a sophisticated economy, like Rwanda, relies on its stock exchange to help businesses raise capital and give investors opportunities to back new and established enterprises. Rwandans are as likely to invest in their stock market to build wealth as people in other nations, which proves that the role of the stock exchange in any economy is universal.

    The first stock markets were established in 17th century London coffee houses. In place of the sleek electronics and frenzied trading floors typical of today’s market, folks interested in owning commercial shares of businesses came to places like Jonathan’s Coffee House. There, innovators such as John Castaing posted stock and commodity prices for “marketable securities in London,” according to the London Stock Exchange’s historical record. This was the “earliest evidence of organized trading,” moving from coffee houses to an actual exchange on March 3, 1801.

    Stock markets are, first and foremost, financial institutions established to help businesses and entrepreneurs come together to buy, sell and trade shares for the purpose of capitalizing enterprises in need of cash infusions. Were it not for stock exchanges, entrepreneurs would be left to their own devices to find investors, and consumers could wind up at the mercy of unlicensed and unregulated financial products with no oversight. Emerging from the stock market system are unique financial terms and concepts including initial public offerings, or IPOs, an international acronym for new business stock introductions.

    Another role of stock markets is to act as an intermediary for large and small investors seeking to make money outside the realm of standard banking institutions. The role of a stock exchange in an economy is to maximize return on savings that might otherwise languish in static bank accounts with low returns. Stock exchanges promise and often deliver higher profits, and in return, investors receive measures of assurance, diverse opportunities and flexibility. Further, a stock exchange offers investors assurances via formal oversight on investments.

    A stock exchange can serve as a barometer of a nation’s fiscal health, broadcasting the ups, downs, trends and shifts that are the benchmarks of a society’s financial infrastructure. According to financial website UpDown’s Investment Education Center, the symbiotic relationship between a society and its stock exchange can be synchronized to such a high degree that prognosticators and analysts can develop confidence that encourages more investing based on the previous performance of products and the health of the companies issuing these stocks.

    Sophisticated financial market systems require credibility and accountability if they are to function on behalf of businesses and investors as interested in ethics as they are in profits. For this reason, a stock exchange benefits from a formal structure upheld by rules, laws and regulations. Management and operational standards set by governments, bureaus and agencies overseeing stock exchange operations add authority and oversight to the institution, giving stockholders, investors and businesses checks and balances necessary for investor confidence.

    The direct effect of stock market activity can impact a nation’s economy in multiple ways. Stocks fall, spending stops, consumers lose confidence and a nation's financial state begins to falter. Conversely, stocks rise, confidence spreads, spending and investments grow. A nation’s mood can rise or fall on stock market activity and performance, which shows how important the role played by a stock exchange can be in a society’s social and fiscal fabric.

    If one of the stock market’s roles is to bring together like-minded investors, exchanges also serve as fiscal melting pots, giving minority businesses an opportunity to place shares of new company assets before potential stakeholders who might not otherwise learn about diverse new products were it not for the exchange. Few economies can hope to flourish without infusions of new ideas, systems and opportunities -- all represented by cash -- which is why this confluence of financial needs and wants regularly merges on the floor of a vibrant stock exchange.

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    About the Author

    Based in Chicago, Gail Cohen has been a professional writer for more than 30 years. She has authored and co-authored 14 books and penned hundreds of articles in consumer and trade publications, including the Illinois-based "Daily Herald" newspaper. Her newest book, "The Christmas Quilt," was published in December 2011.

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