I wrote a post on this a few years ago. There's a few different roles that capital markets play, but I think the big one in terms of real economic value is probably warehousing. The financial markets - stock market, bond markets, etc - provide value mainly by warehousing credit. (Here I mean credit in a fairly general sense, including any sort of expected value at a later time in exchange for funds now - e.g. stocks are included, bonds are included, futures are included, etc.)
This provides value in much the same way as warehousing grain: when there's a shortage of grain, the grain warehouses can can provide grain for a little while (albeit at a higher price) to avoid starvation. When there's a grain surplus, the warehouses can buy up excess (albeit at a lower price) to avoid spoilage/waste. They smooth out the grain supply in time, and that's how they make money. Same with credit: when there's a shortage of credit, markets crash, and people/companies are desperate for cash. Those investors who were warehousing cash sell it, buying low-priced stocks/bonds/etc in exchange. When there's a surplus of credit, asset prices go back up, and the investors sell their assets off. They smooth out the credit supply in time, and that's how they make money.
Again, this isn't the only way that financial markets provide value; see the linked post for more. But I do think it's the main way.
That isn't always true. Sometimes, when a company wants to raise capitol, they sell their own stock, and you, in buying the stock, are directly giving the company capitol. In that case, the market price, which has been determined by all of this buying and selling, determines the allocation of voting power (and dividends if there are any) between the owners of the older shares of stock and the buyers of the new shares of stock.
Was this supposed to be an answer rather than a comment?
It's helpful to spell these things out, but it doesn't bring me closer to an answer, these are the things that I'm thinking might not be very efficient, most of the money seems to spill into the laps of speculators who are just not using it nearly as well as the company would?.. (If they are efficient investment mechanisms, I will need to see a more detailed argument before I'll understand)
One thing to notice here is that most companies can only benefit from the appreciation of their stock by creating...
v. suprised Bogle of all people didn't understand how spread and liquidity interact for price discovery.
Maybe it's because I don't know something, but I'm not so surprised. Belief that Vanguard and co would have no large effects on markets seems quite expedient for Vanguard. Right now, when people talk about the real world effects of index funds, it's all very negative, so if he can find a way to say "no there aren't any effects", he's going to want to.
Negative effect I've heard claimed: Empirical evidence of Index Funds getting involved in corporate governance to reduce competition across the whole market (very anti-consumer), negative effect I (uninformed) am considering claiming: Index Funds are kinda dumb money that goes to the incumbency, instead of to domain-expert investment firms, nor to new challengers.
Regardless of whether they're really bad or not, it is damned scary to see that the largest shareholders of most large companies now are the same three enormous organizations that know absolutely nothing about them.
Jack Bogle, the creator of the first index fund, says
My response to this has always been... if that's true, what is the point in all of this? It's a mechanism that predicts the success of companies, but plays only a very small role in investment? Could we get that money to do something better, then?