Hail the Speculators! They Take the Necessary Economic Risks in Our Economy
There are few individuals as reviled and vilified in our modern age as speculators. Economic turmoil of all shapes and sizes are placed squarely on their shoulders. Why do we have recessions from time to time? Because of the irrational speculators, of course. Why do economic bubbles exist? Because of wild overspeculation, undoubtably. Why are prices rising so quickly? The ceaseless activity of the speculators, no doubt. Yet it is seldom—if ever—asked in the public consciousness whether the speculator serves any valuable purpose. Most believe him to be a pointless and unwanted parasite in society, but is this really the case?
First, what is a speculator? A speculator is someone who leverages money on the outcome of future events. One can speculate over almost anything imaginable: that a company will succeed, that a company will fail, that the economy will boom, that the economy will bust, and on and on. If a speculator is relatively more correct in his view of the future, then he will make money. If he is relatively less correct, then he will lose money. In essence, the speculator appraises what future market conditions will be and invests according to that judgement.
With this description of the role of the speculator, the charges leveled against him are understandable. The speculator doesn’t produce or create anything at all! Why do we need speculators? If what everyone says about them is true, they seem to be much more trouble than they are worth. We can clearly see the economic purpose of farmers, bakers, manufacturers, and so on, but what economic purpose does the speculator serve?
First, it must be noted that the speculator with his forward-looking outlook isn’t unique from an economic point of view. All action, including action on markets, is always forward-looking. Action itself is the desire to utilize means for the attainment of ends. This means-ends interaction is one of cause and effect. Causes and effects never occur simultaneously, meaning that some passage of time is unavoidably involved. This unavoidable passage of time applies to all action. Because action deals in these cause-and-effect relationships, action itself cannot avoid the passage of time. Action always looks to the future, even if only the very near future. This applies to actions in markets as well; buying and selling, whether for production or consumption, are always future oriented.
Even so, we are not all speculators. We might engage in speculation through our actions, but this is qualitatively different than doing so as a profession. Given that speculation is a part of our daily lives, what social value is there in speculation done in pursuit of money? What does the speculator do for any of us?
The speculator, in his estimations and appraisements, alters market prices so that they factor in not only information about the present but information about the future as well. For instance, suppose that scientists announce that a deadly disease has started to spread among the strawberry crop, and that in several years, strawberries will be increasingly hard to find. At this point, the speculator leaps into action. He will start to purchase many of the strawberries being sold now in the hopes of selling them later at a higher price. This increase in present demand, along with the supply now decreased, will increase the price of strawberries. This higher price, however, acts as a signal.
Because strawberries are about to become much scarcer, it is important to conserve them now while we have them so that strawberries don’t entirely disappear when the disease fully hits. Fewer strawberries are consumed now, but more of them will be available later. In essence, that information about future strawberry crops is now being factored into present prices. Who is responsible for this change in price? The speculator.
Assuming that the speculator is correct in our example and strawberries do become scarcer in the near future, then he will be able to sell his strawberries at a higher price than what he initially paid for them, which earns him a profit. If, however, the scientists were wrong and the strawberry crop remains as strong as ever, then he will earn nothing or even lose money because of an increased supply of strawberries now being dumped on the market which lowers the price.
Given that the role of the speculator is to help bring market prices in alignment with present and future information, what economic benefit does this serve? One benefit we have already listed above is that market prices now reflect the scarcity of a product not just in the present but in the future as well. This intertemporal transmission of information gives individuals the opportunity to plan their buying and selling decisions intertemporally. Another benefit is that as these market prices are changed according to new information inputs, entrepreneurs can alter their production plans accordingly. If the price of a product increases because of perceived future scarcity, businessmen will be attracted into that field to produce more of that good or service in the future, alleviating that increased scarcity.
In our example, it is a safe bet to believe in what the scientists are saying and for the speculator to act accordingly. In the real world, however, predicting future market events is rarely so straightforward. Speculators are never perfect, and even the best among them still lose money from time to time. However, the money that they earn is not arbitrary. It reflects how accurate they are in helping to reflect future information in present prices. The speculator, despite the endless insults and vitriol hurled at him, performs an invaluable service to the market economy.
Plain and simple, the speculator has gotten an undeserved bad rap. The reason for this is not because of economic theory but a lack of it. Whenever an economic crisis comes around, the general public, economically illiterate as they unfortunately are, naturally look for someone to blame. Scapegoats are as old as time, and the speculator makes an especially appealing victim. Even so, he deserves to be acquitted of all charges in the court of public opinion. Economic theory does not indict him, and we shouldn’t either.