Against the Welfare State – and Bank Bailouts

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The welfare state is undoubtedly one of the elements of government opposed by libertarians, not only due to its inherent injustice and economic destructiveness, but also because of its ability to provide fuel and sustenance to the growth of the metastasising state

If we are launch a critique of the welfare state we must first attempt to define it and to distinguish it from other categories of government activity. Such a task is not an immediately clear cut one as, fundamentally, all government expenditure sustains the welfare of its beneficiaries. If the government launches an invasion of a foreign country, spending on military grade weaponry, aircraft and whatever else will very much contribute to the “welfare” of armaments manufacturers yet we wouldn’t ordinarily classify this as part of the welfare state. Similarly, if the government decides to build a new road or railway line we wouldn’t usually describe this as providing “welfare” to the construction workers who undertake the leg work (although certain “job creation” schemes that simply pay people to carry out pointless work could be classified as welfare).

Whether or not a particular government outlay is classified as part of the welfare state is therefore defined more by its purpose rather than by its effect. The purpose of a foreign war is usually to gain control of valuable resources (even if it is veneered with an alternative justification such as spreading freedom and democracy). The purpose of building a road or railway is to “improve” the country’s transportation and communication networks. None of these projects is designed to provide some kind of comfortable lifestyle to those who undertake them (and, ignoring the possibility of benefiting favoured lobbyists and donors, to the extent that a government has a particular purpose in mind and wishes to achieve it efficiently it will have a desire to remunerate its suppliers as little as possible rather than as highly).

Welfare spending, on the other hand, is markedly different. Its purpose is always couched in the language of providing some kind of “help”, “care”, or “assistance” to the citizenry, as if the government is a giant nanny who appears with an equally giant milk bottle whenever one’s own teat runs dry. Given this, then, we can attempt to define the welfare state as that portion of government activity which is devoted to the sustenance of either the existing lifestyle of a particular citizen or to a lifestyle that is thought to be the minimum that is equitable in terms of wealth and income. The welfare state therefore provides a cushion or relief from events that may intercede in that lifestyle so, for example, if you get sick, the government will provide you with either free or subsidised healthcare; if you lose your job you will be entitled to unemployment benefit; and if you have baby the government will give you some money so that you are able to take care of it and give it an “adequate” upbringing. Granted, this definition if the welfare state is not precise and it will overlap with many other types of expenditure – few government outlays have a single purpose, even if some of these purposes are not made public – but we can be satisfied that it is reasonably accurate.

In spite of the fact that the welfare state is a moral issue and that its proponents believe that its existence is justified by the fact that the able should take care of the less able (“from each according to his means to each according to his needs”) it is arguable that the strength of its cause derives more from a misunderstanding of economics and that an amelioration of these misunderstandings is likely to weaken the foundations of the welfare state most effectively. Rather, therefore, than elaborating on the fact that the welfare state is, in a genuine free market, a morally unjustifiable confiscation and redistribution of property from its owners to non-owners respectively, let us concentrate mainly on a proper realisation of the economic effects of the welfare state in order to find the source of its undoing.

The type of welfare spending that we will focus on specifically is the bailout of the banks. This selection may appear surprising as surely most supporters of the welfare state are flat out opposed to bailing out the banks? And yet if we look closely, the qualities of bankers’ bailouts fits our definition of welfare spending all but perfectly. The financial services industry was accustomed to its business of expanding credit during the boom years and ploughing them into ultimately unsustainable malinvestments; its practitioners were richly rewarded for doing so and could afford big houses, expensive cars, private schools for their children, exotic foreign holidays, and so on. Metaphorically, they became accustomed to a lifestyle of gambling and partying fuelled by the punch bowl of monetary expansion. Following the inevitable crash that revealed the extent of the malinvestments and the huge losses that would ensue, the bailout of the banks was designed precisely to prevent the liquidation of this crumbling economic structure so that the banks could keep on making loans, keep on making profits from those loans, and so their top employees would not lose the lifestyle to which they had become accustomed. It was meant to refill the punch bowl and to keep the music playing so that the party would never end. The difference, therefore, between bankers’ bailouts and what we typically regard as the welfare state is simply a matter of degree, not of kind. They each provide a taxpayer funded cushion for their respective beneficiaries that insulates their lifestyles from the effects of either their own choices or from events that are beyond their control. Indeed, the collapse of the financial services industry as we know it would also have seriously curtailed the ability of governments to retain their accustomed lifestyle of borrowing and spending. To that extent, therefore, the bank bailouts were an exercise in self-preservation. The only perceived difference between bank bailouts and the welfare state is that the beneficiaries of the former were “rich” and not “poor”, which, it must be understood, is itself a misrepresentation. Many of those affected by a collapse of the financial services sector would not necessarily have been multi-millionaires as any insolvencies and downsizing is likely to have hit those lower down the pecking order first such as local branch managers and tellers before it hit those in the penthouse offices.

We have outlined this description of bank bailouts because every single argument that welfare statists use to oppose them are, in fact, the very same arguments that apply to their conception of the welfare state. We will therefore take each of these arguments in turn and show just how both bank bailouts and the welfare state, which are both a form of welfare spending, are economically destructive.

The first argument against the bank bailouts used by its opponents is that it creates moral hazard. In other words, if the banks can privatise their gains yet socialise their losses it provides an incentive to carry on and, indeed, augment the very destructive activity that was the source of the problem in the first place. All of this is true and we can have no quarrel with it. Yet it applies equally to the welfare state as well. Proponents of the welfare state imagine that if the government throws money at all of the events that manifest themselves as pitfalls in one’s own lifestyle then these pitfalls will simply go away. However if the government simply pays for a problem when it occurs then it creates as much of a moral hazard as the bank bailouts because all you have done is simply lowered the cost to individuals of bearing these pitfalls – and lowered cost leads to a swelled demand. If you pay people when they get sick, there will be more sickness; if you pay people when they are unemployed there will be more unemployment; if you pay people when they have children people will produce more children that need a roof and need feeding. The welfare state is not the solution to the problems it seeks to resolve; it is, rather, a fertiliser for their growth and proliferation, just as bank bailouts are a fertiliser for the growth of credit expansion, malinvestment and repeated boom and bust cycles.

The second argument against bank bailouts, related to the one we just outlined, is that it shoves the cost of the bad decisions of the bankers onto the shoulders of everybody else. Yet isn’t this precisely what the welfare state does? Welfare statists imagine that nearly every unfortunate circumstance in which people find themselves is not the product of their own making and that they are therefore blameless and should be (patronisingly) pitied – in short, that people do not bear any responsibility for their own circumstances. However, this is not the case with many of the issues that the welfare state attempts to address. As was argued in a previous essay on universal healthcare, the majority of medical ailments from which people suffer are not the unfortunate result of a random, illness lottery but are, rather, directly related to their environment and lifestyle – particularly diet, exercise and consumption of alcohol, tobacco and narcotics. If, therefore, people choose to pursue a lifestyle of eating gluttonously, exercising little and smoking and drinking heavily with this resulting in sickness, then if the government picks up the tab this simply forces the cost of these bad decisions onto everyone else. People, in most cases, choose to have children, or at least to engage in the intercourse that results in children – it isn’t a random, spontaneous event that appears out of nowhere to inflict itself upon people’s lifestyles. To the extent, therefore, that people cannot afford to raise these children properly and the government intervenes then the cost of other people’s bad decisions is again shovelled onto the shoulders of everybody else. But even those aspects of the welfare state that are not necessarily the fault of the individuals concerned – such as unemployment – is usually the result of government anyway. Low employability is caused not only by inadequate state education, but also government interference in the labour market such as minimum wages and excessive regulations that cause the cost of employment to exceed that of the productivity of the lowest skilled workers. Why, therefore, do welfare statists propose a government solution to what is a government created problem? Why not just get rid of the government created problem?

The third argument against bank bailouts is that they perpetuate what we might call a crony “corp-tocracy” where taxpayers’ money is siphoned off into the hands of the government’s favoured millionaire chums. Yet this is precisely the result of the welfare state also. Although the nominal beneficiaries of the welfare state are individual people, someone has to be paid in order to carry out the work of the welfare state. Not only does a welfare state require the creation and sustenance of a vast, leeching bureaucracy to administer it all but particular parts of the welfare state have to be contracted out to individual specialists. For example, public housing schemes need to find construction companies, hospitals need to find doctors and they need to purchase medicines from drug companies. The interests of these suppliers to the welfare state is to ensure that their compensation for carrying out their tasks is as high as possible; indeed, one of the reasons why the welfare state is such a burgeoning expense is because the disconnect between the consumer that pays and the supplier that is paid results in spiralling costs for the services of the latter, with the result that the majority of welfare spending goes not to the individual people but straight into the bank accounts of large corporations and contractors. Moreover, the welfare state is not usually a fixed pool of services that are provided by the government, but includes also private organisations and charities that lobby the government for money in order to solve the particular societal “problems” and grievances that they happen to have identified. Much of this money is simply wasted, as suggested by the recent collapse of Kids Company, a UK children’s charity, around a week after it received a £3 million grant from the government. Indeed, in the UK – when the chief executives of high profile charities are paid six figure salaries and they have been chastised for “aggressive” funding raising strategies that were recently attributed, at least in part, to the death of a pensioner – the substantive difference between a charity on the one hand and a corporation on the other is becoming increasingly questioned.

The fourth argument against bank bailouts is that they distort the economy, shovelling excess funding into the financial services sector and expanding their profits at the expense of other industries. Again, nothing about this is untrue and, indeed, as “Austrian” economists we would make an even more detailed case about how the resulting credit expansion distorts the consumption/investment ratio in order to result in unsustainable malinvestments across the entire economy. Yet the welfare state distorts the economy also, only in a more incremental and pacing manner. In the first place, the increased incentive caused by the welfare state to exacerbate the very problems it is supposed to solve, such as sickness and unemployment, reduces the capacity of the labour market and thus shrinks the extent of the division of labour that would otherwise have been possible. Second, the burgeoning cost of the welfare state caused by an artificially inflated demand for welfare requires more and more resources to be confiscated by the government in order to fund it. Thus, the areas of the economy that are devoted to providing welfare are swollen at the expense of other areas of the economy which must correspondingly shrink. Third, this is compounded by the fact that a large, government pot of gold encourages rent seeking behaviour, which in the case of welfare means (as we stated above) large numbers of special interest groups lobby the government each with a claim that they have identified some societal affliction that is ripe for resolution by government spending. Governments are eager to attract this kind of attention for more government spending means not only more power and prestige but also provides another outlet with which to bribe citizens with their own money when making election “promises”. The result of this, again, is that the total portion of the economy that is devoted to welfare spending is artificially inflated compared to what consumers would otherwise prefer.

The final argument against bank bailouts that we will consider is that they create a feeling of bitterness and resentment in the general population, a fissure of hate, contempt and distrust between the bankers and the people whom they supposedly serve. Again, all of this is true. However, it applies just as readily to the welfare state. Its proponents usually justify the imposition of the welfare state by stating that it is morally good for us to care and look after one another as if we are all one big family. This may be true enough, but the welfare state does not create that situation. In order to become a morally better person I have to choose to care and to look after my fellow man – I have to decide to do it voluntarily. I am looked upon with admiration because in spite of all of the personal luxuries I could have spent my money on, I willingly deprived myself of them and was happy to give the money to a person in need. The welfare state, however, does not give me any choice in this regard – it just forces me to do it regardless of what I want. The action, therefore, is not as the result of any personal sympathy or empathy for the plight of the less fortunate, nor of any aspiration to moral heights. Instead, the void left by an absence of sympathy and empathy is likely to be filled by bitterness and resentment as my hard earned money has just been confiscated from me to go to people who I believe may not deserve it, particularly if it goes to some cause that I may disagree qualifies for welfare spending (such as breast enhancement surgery on the NHS or unemployment benefits to those who are just workshy). The welfare state therefore creates the opposite of any charitable feeling whatsoever and destroys any notion of brotherhood or family. When this is coupled with the welfare state’s encouragement of the afflictions it seeks to solve then the result is a society with a lower, rather than higher, moral standing. This is exacerbated by the interdependent relationship between bank bailouts on the one hand and the welfare state on the other. Bank bailouts mean that the banks take the money of the taxpaying public and plough it into assets so that the income of anyone who owns these assets – i.e. the bankers themselves – is swollen while the incomes of those who do not stagnates. The resulting price inflation lifts the affordability of assets such as houses and basic necessities, such as food, out of the grasp of those on low incomes. The consequence is another artificially swollen demand for welfare to give ordinary people somewhere to live and something to eat. Thus, the poorest in society demand increased taxes on the rich – i.e. the very bankers who were bailed out – in order to fund increased welfare spending. The result, therefore, is a toing and froing of mutual theft, a circle of robbery where bankers demand taxpayers’ money to continue their casino operations, after which everyone else demands some of it back to ameliorate the resulting effects. Far from being a moral and harmonious society all we end up with is hating each other and trying to grab whatever we can out of each other’s pockets.

What we can see from this brief comparison of the welfare state to bank bailouts, therefore, is that there is very little qualitative difference between the two and that the arguments that are used to oppose bank bailouts apply just as easily to the welfare state. The amelioration of welfare demand is achieved not through the redistribution of a fixed pool wealth but through the raising of real incomes by increasing the productive output per person. In order to achieve this we need to eliminate both the bank bailouts and the welfare state so that we can return to a genuine economy where everyone serves each other rather than engages in mutual plunder. The rich would have to earn their wealth by directing and increasing the productive capacity of the economy to best meet the needs of the consumer; the poor earn their money by providing the labour to bring about this direction, with their wages being able to buy more and more goods as a result of the increased output. Not only would this create a more prosperous society where poverty has truly been consigned to the history books, but the vanquishing of hatred, resentment and antagonism would create a morally superior one too.

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Economic Myths #1 – Rising Prices = Recovering Market

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One of the positive indicators of our so-called economic recovery bandied about not only in the media but also by our monetary lords and masters at the head of central banks is the idea that rising prices (particularly in the housing market) are a sign of economic recovery. This mistaken belief is part of a wider myth that views the economy as a big number, a number which, if going up, means things are good and getting better, and if going down means the situation is bad and getting worse.

Theoretically the market price for any good is never “good” or “bad”. It simply a function of supply and demand for that good. However, if anything, relatively high prices indicate a scarcity of goods relative to the money used to buy them rather than an abundance. This situation may be a localised boon to those who are in the business of selling the scarce good, but for those of us on the other side of the transaction having to pay more hardly suggests a general increase in our prosperity. For if society is getting wealthier and producing more goods we should find that we are be able to buy more with the same amount of money rather than less – hence, prices should decline and not rise.

What is of course meant by the “recovery” of rising prices is precisely a localised recovery and improvement for a select group of people – those who borrowed cheap money heavily during the boom (mostly the politically connected big banks and investment houses) and ploughed it into assets. They can now breathe a sigh of relief as the prices of those assets once again begin to rise with the new round of monetary inflation. The rest of us, on the other hand, have to sit by and watch the purchasing power of our wages drop, unable to continue to afford to buy things because the “recovering” prices put them out of our reach.

A general recovery is not based upon rising asset prices buoyed up by paper money. It is created by a sound monetary order that allows entrepreneurs to allocate resources to where they are most urgently desired by consumers. The result should be a gradual secular price deflation, so that the money in the hand of the lowest earners gradually increases in value, enabling everyone and not just the super rich to grow wealthier and more prosperous.

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Speculation

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One of the most vilified activities associated with the capitalist economy is that of speculation. Even in a world where managers of large multinational firms and wealthy shareholders are denigrated as evil, greedy and exploitative, the full brunt of the most concentrated ire is directed towards the class of persons branded as speculators. Indeed they are a convenient scapegoat for a whole host of (often contradictory) symptoms of an ill economy or financial system – rising prices, falling prices, volatility of prices, inflating bubbles, bursting bubbles, price gouging, supply shortages ad infinitum. Even successful investors and their mentors – Warren Buffett and Benjamin Graham respectively, for instance – are keen to point out how their methods differ from speculation and reserve the word for describing arbitrary, capricious, and undisciplined trading. More than any other aspect of the free market, then, it would appear that speculation is in need of the most detailed clarification and defence. What will be elaborated is that speculation is endemic not only to all exchange, trade, business, production, etc. but also to the very nature of human action itself. Further, following an explanation of the different ways in which it is possible to speculate, it will be demonstrated that no principled distinction can be made between anyone who tries to “buy low and sell high” and that perceived differences that are used as grounds for criticism are instead based on the relative difficulty in visualising the true economic effects of some speculative activities.

Valuation and Human Action

Humans act because they wish to direct the scarce resources at their disposal to and end that is more highly valued than the alternative use to which those resources may be put. If this was not true humans would not act. All human activity, whether it is brushing one’s teeth or purchasing a bag of groceries right up to selling a house or trading billions of dollars worth of securities on the financial markets are all carried out because the acting individuals perceive that the value of the outcome is higher than the value of the alternative. I brush my teeth because the act, I believe, will produce clean teeth that I value more highly than doing something else while retaining dirty teeth. I buy the groceries because I value them more highly than the money I am using to pay for them and other things that I could have bought. I buy a house or securities on the financial markets for the same reason.

However all valuation is ex-ante, that is we must decide what the valuations of our outcomes are before we act. We do not act out all of the different things we could do with our resources and then cherry-pick the one that actually yields the most valuable outcome. Rather we have to anticipate that the resources chosen and the method of our action will actually bring about the end that is sought and that this end will indeed have the value that we believe it will have. In short, we speculate on the outcome of our actions and all of our actions are, therefore, speculative.

Different actions have differing degrees of speculation, particularly when we have experience of the outcome. Most people will be fairly confident as to the results of brushing their teeth, both in terms of the physical product and the value it has. It’s not likely that after the act of brushing the teeth will be in a condition we did not expect, nor are we likely to regret what we have done and wish we had done something else. Further we are not likely to have undervalued the outcome ex-ante and end up wishing that we had devoted even more resources to produce more of the outcome. Other actions, however, are less certain. When a person buys a new product from the grocery store he doesn’t necessarily know whether the enjoyment of the taste and the satiation of hunger will outweigh the money spent on it. In order to mitigate this uncertainty he may at first be reluctant to devote too many resources to it, perhaps only displaying a willingness to purchase it when its price is reduced. After he has eaten it he may feel that he made a satisfactory trade and that he is glad that he purchased the good for the amount of money he gave up; alternatively the meal may be so ghastly that he deeply regrets the experiment and, if he could go back in time, would keep the money and not buy the product. However another possibility is that it might be so enjoyable that he regrets not having spent more money on the good and that the other uses to which he devoted another part of his money ended up being wasted as a result.

The point, though, is that all valuation of our actions is made ex-ante and that they are, therefore, speculative. Even with a commonly repeated act such as brushing one’s teeth there is no certainty. What if the time you devoted to brushing your teeth caused you to miss something important on the television and that, if you had your time again, you could go back and leave the brushing until after the show had finished? Speculation is, therefore, not only an essential and undeniable aspect of human action, one that we are immutably bound to using, but the very generator of human action itself – it is the impulse of our belief that we are moving on to something better with each act that causes us to act. It is no exaggeration to say, therefore, that speculation is at the heart of the nature of human living. Everyone is a speculator.

Market Participants and Exchange

Having established, therefore, that speculation is the anticipation of value arising from an action that is greater than that which preceded the action, let us narrow our focus to where speculation is typically used as nomenclature for these activities of valuation – the marketplace. But are we to crown only those traders who stare at price charts on six computer screens all day as “speculators” or is the scope of the definition much wider?

The “free market” (a much-abused term usually deployed by those opposed to it to signify disconnection from and lack of control by “ordinary” people) is an abstraction for people, individuals, voluntarily buying and selling. But why do they buy and sell, or to use a more precise phrase, why do they exchange? Here we come to a second important law of human action – that in order for two individuals to exchange goods, each must value the good that he receives more highly than the good he gives up. If A owns good a’, B owns good b’ and they agree with each other to exchange these two goods then it must be because A values good b’ more highly than he values good a’ and B values good a’ more highly than he values good b’. If this was not true why would the exchange happen? If the good you wished to acquire you viewed as equal in value to the good that you give you up why bother to exchange it? If it is of equal value what are you gaining from the action? Any doubts about this truth can easily be purged by considering one’s own experiences. You work to earn money but you cannot eat money and it cannot provide you with shelter, clothing, etc. At some point you need to buy goods that will remedy these deficiencies and you do this because the goods become more valuable for you than the money. Conversely the vendor of the goods wants your money more than he wants the goods.

It follows therefore that if market participants are attempting to gain value through trade, and the value can only be anticipated in the way that was outlined above then aren’t all market participants speculating? Aren’t we all expecting that what we gain from an exchange will be of greater value than that which we gave up but live with the fact that our expectation might either turn out to be true, turn out to be really true to the extent that we wished we’d exchanged more or turn out to be so untrue that we really wished we had not made the exchange? Everyone in the marketplace is therefore a speculator and all market transactions are speculations – speculations on what is gained in exchange will be more valuable than what is given up.

Let us concentrate, however, on the market participants who buy and sell, i.e. the relationship of exchange does not end with their purchases as in the case of a consumer. Consumers, after all, are expecting psychic gain. When a consumer purchases a steak he is expecting the enjoyment gained from eating it to be greater than the money he gains from it. With other market participants, however, the goods they exchange are not for their final enjoyment – they are to be bought with the desire to sell them again in due course. Here we have the starkest and simplest way of determining a gain in value from an exchange – that the price at which you bought a good is lower than the price at which you sell it. All market participants other than consumers aim at this end. And once again the participants can only expect that the good will sell at a price higher than the price at which it was bought. All market participants are, therefore, speculators and the object of their speculation is the variation in price of an economic good. It does not matter who you are – a corner shop, a restaurant, a bank, a large multinational firm, a derivatives trader – all speculate that the price at which they purchase the factors of production will be lower than the price at which they sell the final article to their customers. Price movement, therefore, is king to the speculator.

Prices

It is an economic law that the market price is a function of the supply of an economic good and its demand. If the market price is at a level where the quantity of the good that is demanded is equal to its supply then the price is said to be at the equilibrium price, or the “clearing” price. As the quantity demanded equals the quantity supplied all willing market participants – buyers and sellers – are satisfied at this price. All of the willing buyers go home with however many units of the good they wished to buy and all the willing sellers go home with however many units of money they wished to sell for.

It follows, therefore, that if there is a change in supply or demand then one set of people must become unsatisfied. If, at the current price, demand increases but supply remains constant there are now, suddenly, not enough willing sellers to supply the goods to all of the willing buyers. The result is that price must rise to a point at which the willingly supplied stock can be rationed to the sudden influx of new willing buyers at the old price. Conversely if supply increases but demand remains equal then price must fall to a level at which the increased supply can find new, willing buyers who were not prepared to pay the higher price.

Disequilibrium in the relationship between supply and demand therefore causes prices to change. It is the ongoing and varying disequilibrium that causes the price movements in goods that we commonly associate with speculators – in stocks, bonds, currencies, commodities, real estate etc. But the currents of supply and demand are common to all prices, even those that appear to hardly change at all from day to day.

As we already established a speculator in the marketplace is a person who “speculates” on the prices of goods – he believes that the price which he pays for a good today will be lower than the price that he is able to sell it for in the future. But, as we just explained, this can only happen if there is disequilibrium in the relationship between supply and demand. What follows, therefore, is an important, applied economic law that is seldom realised by even the market participants themselves: that anyone who buys goods in the marketplace with the desire to sell them at a higher price at a later date is necessarily intending to buy at a price level where demand already or shortly will exceed supply, necessitating a rise in price, and to sell them either when price reaches equilibrium or when supply exceeds demand. All persons who buy and sell aim to do so at these points. All market participants are therefore speculators on the disequilibrium between supply and demand. There are no exceptions to this law – every investor, entrepreneur, manager, businessman, capitalist, shopkeeper, distributor, agent, anyone you can think of who wants to “buy low” and “sell high” must and can only find the places where demand and supply are in disequilibrium. It follows that the buying and selling where the disequilibrium is greatest will yield the most handsome profit margins.

Methods of Speculating

We are now getting closer to the area where the most common grumbles about the act of speculation lie – that the speculator just buys something, sits on his rear end, waits for the price to rise and then sells it. “But what on earth has he done?!” cries the typical lament. “What value has he contributed? How has he improved the situation at all and why should I pay this person a ludicrously high profit?!” Such vitriol is usually reserved for certain types of market occupation – investors, bankers, middle men, and agents for example. But we must remember that all market participants are speculators and so there is more than one way of anticipating where and how the supply and demand for a good will change. Further, as will be demonstrated, all speculators, in whichever occupation they are working, must, if they are successful, add value.

What, then, are the methods of speculating? What is the focus of the individual speculator when he is buying low and selling high? They are one of three things – that the speculator must either a) transform the good into another good, b) change the location of the good or c) change the time of an economic good. Little needs to be said about a) except that it always involves a material transformation of a combination of goods into the final good; b) is effected  by transporting the good from one location to another; and c) by buying it, withholding it from circulation and selling it at a later date.

In practice, of course, it is an economic fiction to treat these aspects entirely separately; for a start all methods of speculation must take place through time. Further we could argue that a change of time or a change of location is also a change of form – that, for example, oranges in Florida are a different economic good from oranges in London, or that Christmas trees at the height of summer are a different good from Christmas trees on December 25th. However from the point of view of the physical actions and preoccupations of the speculator they are separable and analytically different methods of speculating. How then do these methods of speculation take advantage of changes in supply and demand?

If a speculator transforms an economic good then he takes pre-existing goods and turns them into another good, a finished product for sale. It is easy to envisage this as almost every manufacturer fits into this category, whether he is a sole trader or a large factory. A carpenter takes wood, tools, varnish and his labour and produces may be a table or a chair. A printer takes plain paper, ink, staples or binding fluid, and labour and turns out a book. A car plant or plane manufacturer takes hundreds of factors of production in order to turn out their products. Such transformation can take place with previously produced goods or with land (in the economic sense). The carpenter’s wood, for example, has already been transformed from a tree into a plank, whereas a farmer has to take land, seeds, water sunshine and labour and turn them into crops. Further, the transformation is not limited to tangible goods but also to services. A taxi driver will take a vehicle, fuel, a payment meter, his labour and produce with them a journey for a customer. Nothing physical that the customer can hold in his hand results, but the factors have combined to yield a valuable, intangible good.

How is it, then, that a transformation produces the all important increase in value, indicated by aiming for selling the produced good at a price higher than the price of the individual factors? It can only be by buying factors that are in low demand relative to supply and transforming them into a good that is in high demand relative to supply. The several economic effects of this service are important. First, it discovers an economic inefficiency that is ripe for correction – factors that are used to produce a good that is highly valued are, in and of themselves, relative undervalued. The larger the profit margin the greater the extent of this disequilibrium. Secondly, such a discrepancy means that the factors, because of their cheapness, will be directed towards production processes with less valuable ends and will be conserved with less zeal. Hence factors that could be used to produce a highly valued end are, in and of themselves, being wasted on lesser ends. When the speculator begins to buy these factors he creates for them an additional demand. This additional demand drives up their prices, rendering them too costly for other, less valuable ends and diverting them instead to the more valuable ends. Hence resources are no longer wasted. Finally this discovery of the discrepancy and its subsequent correction, yielding a large profit margin, will encourage competitors to enter the field. Thus, the factors will be bid up even more thus driving their price up further while the supply of the finished product will increase, hence lowering its price in turn. Profit margins therefore decrease as the increasing cost of factors approaches the decreasing selling price of the final good. Investment will continue to increase and the industry to expand until profit margins no longer justify it and funds are attracted to other projects whose discrepancies and imbalances have now become relatively more pressing. Hence speculation – the discovery of imbalances between demand and supply – prevents the waste of resources by identifying wide profit margins and closing them. As result the scarce factors of production are directed to their most highly valued end. And this is the essence of economic efficiency, getting the greatest value out of scarce resources1.

However, there is no guarantee that the speculator’s buying prices will be higher than his selling prices. Just as the consumer does not know in advance whether the new product he bought from the grocery store will end up being worth the money spent, so too does the speculator not know whether the price of the good he sells will be higher than that of the goods that he combined to produce it. It may be that his customers are satisfied with the product and will purchase it at a modest premium, in which case he identified a discrepancy in the market but it was relatively minor. He has provided a service but the factors of production clearly have very competitive alternative ends into which they could be drawn, otherwise their price would have been lower and the profit margin higher. The speculator has therefore done an important service, but not one of tremendous magnitude. Alternatively the customers may be absolutely delighted with the new product and rush to buy it as quickly as possible. Demand is so high that the speculator can barely keep up with orders and the only way to ration the existing stock is to raise the price. The increase in price will, therefore, increase profit margins. Hence the speculator here has identified a very wide and serious imbalance in the economy, a pressing and urgent desire of his customers for a product whose factors were highly under-utilised. Or, the undesired outcome, the speculator finds that he cannot sell his finished product for more than the factors of production and that he therefore makes a loss. He has, erroneously, diverted factors that were in high demand relative to supply and transformed them into something lower in demand relative to supply. Hence the factors have been wasted as the high demand for these factors indicates that there were more pressing needs to which they could be diverted. However, the waste is quickly cut short because no market participant wishes to or even can sustain losses. At some point, even if he persists with the loss making enterprise, there will a come a time when he runs out of money. He therefore loses the ability to continue to divert resources to wasteful ends and his proven lack of talent for speculation eliminates him from that role in the economy. The successful speculators however, in gaining profit, are able to command more resources than they were before. Their successful identification of where to divert the scarce factors of production means that they are trusted with being able to do so again with more. But if they make one error in identifying the desires of the consumers they will begin to make losses. They must therefore be continually successful in identifying the most pressing needs of valuable economic resources.

As we have already said speculation is necessarily forward looking – the anticipation that the value yielded by an act is greater than that of what persisted before. When it comes to the speculator who buys and sells goods what we see is that the valuation runs in a direction reverse to that of the sequence of events. The first speculator in what could be a very long chain of production is motivated by the valuation of the final consumer (who may not appear to buy for many months or even years) that is expressed through the chain by the valuations of all the other speculating intermediaries and directly by the particular speculator who will purchase his product from him. All speculators are, therefore, acting ultimately in the service of the final consumer by ensuring that scarce resources are directed to their most pressing needs.

Having explained the economic effects of speculation with reference to speculators who transform economic goods the remaining categories can be elaborated relatively swiftly. However with transformation it is relatively straightforward to visualise the productivity of the speculator; indeed the word speculator is seldom associated with what are perceived as routine businesses. This, as we have shown, is a misunderstanding as all actions are speculative and calculably so when they involve buying in order to sell for money. However with speculators who change either the location or the time of a good understanding of precisely what is going on becomes more obscure, resulting in the perception that either these types of speculator are either adding no value or, worse, are actively destructive and exploitative. These beliefs will be demonstrated to be false.

With the speculator who changes the location of an economic good we have the first case of the dreaded middleman – the agent, the dealer, the distributor and the marketer. These people buy an economic good, do absolutely nothing to change it and then sell it for a higher price, so the argument goes. If however, they are not adding value then it raises the question of why people are willing to pay the mark-up. Are the speculators simply ripping people off or is there a genuine reason why they are able to sell their goods for higher than the price at which they bought them?

Let us take the example of the distributor. He buys goods in one location, transports them to another and sells them at the latter. But why is he able to sell them at a higher price at the final location? Going back to our analysis of prices it can only be because the goods at the original location are in lower demand relative to supply whereas the goods at the final location are in higher demand relative to supply. In other words the speculator has identified an imbalance in the market – goods at one location are plentiful and lowly valued relative to another location and the speculator steps in to correct this imbalance. This is straightforward to perceive with goods that can only be manufactured or produced at certain locations on the Earth either because of climate or because of the ease of access to raw materials. Let us assume that a certain good, oranges, can only be produced in Spain. At that place there is a very heavy supply of the oranges as the crop ripens – baskets and baskets of them are stacked up in the groves. Oranges may be so abundant that they exchange for pennies and people devote their use to meet all sorts of ends – eating, juicing, garnishing, animal feed etc. However at other places on Earth – let’s say, London – oranges are not produced at all and are in very short supply. Consequently they trade for a very high price and as soon as someone gets his hands on an orange he will conserve it and take extra care to make sure he devotes it to his most highly valued use (lets say eating). It is unlikely that you would find Londoners using this rare fruit as animal feed.

The actions of the speculator who steps in in this case differ in no way at all from the speculator who transforms goods. His buying action will drive up prices in Spain that curbs the relatively wasteful uses to which oranges are directed; his selling action will drive prices down in London, allowing more people to enjoy the fruit and to devote it to a wider number of uses than they could before. The height of his profit is determined by and will demonstrate the height of the economic imbalance between the two locations, encouraging competitors to also enter the field and continue the buying in Spain and the selling in London, thus reducing profits. This will continue until the return no longer justifies the costs of transportation2. Therefore just as where the transforming speculator brought about a unity in price between the factors of production and the final product the speculator in location brings about a uniform price for goods across all places (less transportation costs). Thus economic resources are not just channelled to their most highly valued form but also they are transported to their most highly valued location.

Economically the speculator in location is no different from the speculator in form its just that the focus of his operation, his expertise, is location and not form and it is, hence, analytically easier to deal with them in these categories. However he does take factors – oranges in Spain, wooden crates, trucks, fuel and labour – and transforms them into oranges in London and the latter is really a different good from the original. Hence he has produced a good in a different form except that this is not evident from the physical quality of the final good. It is this obscurity that leads to questioning over the added value of this type of speculator’s activity.

It could also be said that a further benefit of the speculator is that he eases the burden of the previous producer. For example, by buying the oranges from the farmer the speculator relieves the latter of having to find a market for his product. The farmer receives a definite price now rather than having to, himself, arrange for transportation, marketing and whatever else in order to sell his product elsewhere on the planet. He can therefore concentrate his time and resources on farming the oranges. The car manufacturer sells to a dealer so the latter then takes on the burden of having to sell them to consumers. The same is true also of those who change the form of goods – the carpenter relieves the lumberjack from having to fashion the wood into tables and chairs; the goldsmith does need to learn how to fashion jewellery as the jeweller will buy the gold from him and do it instead. Hence the more speculators there are trying to analyse differences between buying and selling prices in different markets then the greater becomes the extent of the division of labour – each market participant only needs to concentrate on and consider a very small section of the entire economy and may be completely unaware of where his factors came from and where his final product will end up. Such specialisation leads to enormously greater productivity and, indeed, is the very raison d’être of the extent to which humans have, at least in some parts of the world, achieved a standard of living far in excess of that when they first walked the Earth.

Finally let us turn our attention towards the speculator who changes the time of an economic good. Here lies the, apparently, most lazy and undeserving of all speculators – the person who buys something, holds it then sells it a higher price while having added nothing of any value whatsoever. Such a point of view again overlooks an analysis of supply and demand3. If the speculator buys at a time when prices are low it must be because the demand for the good is low relative to its supply. Nevertheless the speculator is anticipating that demand will rise at a point in the future, a point that will cause prices to rise and allow him to sell at a profit. If the speculator is correct, therefore, then it means that the good in question will become, in the eyes of the consumers, scarcer than it was before. Something that today is relatively valueless will tomorrow become desperately sought after. The speculator’s buying actions therefore serves to remove the good from circulation at a point when demand is low. This removal prevents it from being wasted by a diversion to a less urgent use today when it will be needed for a more urgent use tomorrow. Once prices have risen as a result of the anticipated increase in demand, the speculator releases the good for sale on the market again, but now only those that most value the good will be willing to pay the higher price. Hence the resource will be devoted to its more urgent uses. Speculators in time therefore conserve resources in times of plenty and release them in times of scarcity. It is almost exactly like the squirrel who, during the summer and the autumn when nuts and fruits are in abundance, abstains from consumption of a part of them and stores them away. Come the winter and the spring when these goods are scarce he has plenty to consume that he would not have had but for his saving and storage. Indeed, seasonal products or products that have a long period of production (the longer the production period the more uncertain the final selling price of the good) are those that are ripest for speculation in time. The general effect of this speculative activity on the market is a reversion of prices to the average. If we assume, for the sake of simplicity, a constant demand for wheat during the year, at harvest time there is plenty of wheat to satisfy this demand and so prices will be very low. Wheat will be so cheap that people will gobble it up and devote it to minor and un-pressing needs on account of its abundance. However in the winter wheat will be very scarce and will therefore command a high price. There will not be enough to go around and what little there is will be devoted only to the most urgent needs. However in summer the speculator, by introducing additional buying pressure when prices are low, will drive prices up towards the average annual price and in winter, by introducing selling pressure when prices are high, will push prices back down to the average. The result, therefore, is a stable, annual price for wheat throughout the entire year in spite of the seasonal variations in supply. This is why consumers are able to pay the same price throughout the year for grocery products that are produced with seasonal factors of production.

Similarly to other forms of speculation the height of the difference between the buying and the selling prices determines the scale of the economic imbalance, most noticeably after poor harvests. In these years speculative action, reaping handsome profits because the price rises so high, serves to conserve what little of the crop there is for those who need it most urgently.

Of course those speculators who behave contrary to what supply and demand are doing – those who sell when prices are low and hence drive down the price even further when the good is in hot supply, or those who buy when prices are high thus choking off even the most willing buyers from being able to purchase the good – will quickly lose funds and go bust, ending their short reign of destructive buying and selling. For no speculator, in the long run, can change the ultimate direction of prices; every speculator who buys at some point has to sell. His buying pressure that raises prices today will become selling pressure that lowers them again tomorrow. The overall price and its movement can only be determined by original supply of a good by its producers and the final demand by its consumers. The alleged volatility of prices and bubble formations that are allegedly caused by speculative activity will be dealt with below.

A further benefit of speculation in time is the correction of momentary price discrepancies. A seller offers a good for sale at a price below the market clearing price where demand outstrips supply. The speculator purchases the good and offers it for resale at the market price, pocketing the difference as profit. By purchasing at the lower price the speculator ensures that sub-marginal buyers are not able to get their hands on it and divert it to less urgent uses; by selling it at the higher price he conserves the good for the marginal and supra-marginal buyers who will divert it to more urgent uses. Conversely a buyer may offer to buy a good for higher than the market price where supply exceeds demand. Here the speculator will short sell the good, borrowing it and selling it at the higher price before buying it back at the market price and returning it to the lender. This means that sub-marginal sellers are not able to sell their goods ahead of the marginal and supra-marginal sellers, ensuring that the former cannot crowd the market with wasteful surpluses that will find no buyer at the high price.

It should be clear that the speculators’ profits in cases of momentary price discrepancies are funded entirely by the erroneously dealing sellers who sell too low or the erroneous buyers who buy too high. They must bear the penalty for trading at a price level where supply and demand are not in equilibrium. Those buyers and sellers who are prepared to trade at the market price do not suffer at all; indeed buyers are benefited by the prevention of a shortage of stock resulting from prices below equilibrium and sellers by the prevention of surplus stock resulting from prices higher than equilibrium. Of course if the speculator himself is on the wrong side of these trades then he is the one who is punished with losses. If he, for example, suspects that the current price is below the market price whereas it is in fact at or above the market price, he will buy and then attempt to sell at an even higher price. But at this price there are few, if any buyers, willing to purchase all of the stock from sellers who are willing to sell at this level. The only way the speculator can compete with the other sellers is to lower his price until all the stock can be sold at a level that fills every demand to buy. Depending on how erroneous his original price was he may break even or suffer a loss. Repeated losses will deplete the speculator’s funds until he has no wherewithal to speculate further and he is prevented from causing any more distorting activity on the market.

A final benefit is similar to that of the service that the speculator in location provides the orange grower – by finding a market for the product the latter is relieved of the risk and burden of having to do so and can concentrate on farming the product. Similar concerns face those who sell goods with a length of production that is relatively long and which may in and of itself be fraught with uncertainty. Once again crops are a good example. The farmer has to begin production and incur expenditure on factors in the spring whereas he will not reap the harvest and make an income until six to nine months later, during which any number of intervening events could occur that will affect the amount and quality of the final good. In steps the speculator who will, say, at the start of the growing season offer a definite price to the farmer for his whole crop, regardless of how it turns out at the end of the harvest. The speculator, of course, believes that the final crop will be of a quality and quantity that will enable him to earn a profit on what he paid to the farmer. The farmer, in turn, is willing to forego this profit so that he can purchase factors of production and begin work safely with the knowledge that the costs will be covered by a fixed amount of revenue in the future. Hence the risk of future prices is transferred from the farmer to the speculator.

Financial Traders

The financial trader is the speculator in time par excellence. He will buy financial securities that are claims upon real assets, withdraw them from circulation and sell them again for a higher price. Everything essential that needs to be known about this type of individual has been covered in the previous discussion. Nevertheless as the financial speculator in particular is the least understood and most vilified of all market participants some additional elaboration would be beneficial.

The consumer, as discussed above, bases his buying decisions upon whether the object of his purchase gives him greater satisfaction that the sum of money with which he parts for it. His gain is a psychic profit, one that cannot be measured or demonstrated but one that is, in his own mind, either satisfied greatly, somewhat or not at all. It follows therefore that his buying decision is dependent upon the quality of the good that he buys – if it is food it needs to have a nutritional value and taste the benefit of which exceeds the cost that was paid for it. But what of the person who sells it to him? If you are a fishmonger is it your preoccupation (aside from providing advice and recommendations or from utilising a degree of empathy with your customers) that salmon is delicious and nutritious and will provide a great deal of benefit if consumed? Or are you more concerned with the fact that consumers are willing to buy it at the price you offer and, in order to meet this demand, are you not concentrating on where you can source it at the lowest possible cost? A café owner doesn’t care whether coffee is good, bad, or ugly nor does a carpenter care about whether tables and chairs are nice to sit on; indeed both may utterly abhor the products that they produce. The focus of their operations is to recognise that consumers demand these things and they meet these demands by purchasing the factors of their production at the lowest possible cost, raising the price for these factors and hence choking off their diversion to less urgent desires of the consumers. What emerges therefore is a symbiotic relationship where the desire to earn profits on the part of the trader is harmonised with the desire of the consumer to acquire a good that will satisfy him.

If we turn, however, to the financial markets the same relationship is present between what we might call pure financial traders and investors. The latter is inherently concerned with whether the capital goods which he purchases will best serve the needs of consumers. If he must decide whether to invest in either companies A, B or C he must determine which of them (if any) is utilising (or will utilise) its assets in the best possible way in order to fulfil the demand of its customers. Even though, therefore, the investor is, like all market participants, a speculator in supply and demand and ultimately derives his entrepreneurial profit from imbalances between the two, there is an inherently qualitative dimension to his operation, similar to that of the consumer himself.

The market capitalisation of a company represents the discounted value of the company’s future profits – that is the present value of all of the future profits, necessarily discounted because a good available today is of higher value than the same good available at some point in the future. If you were to buy a whole company what you have really bought and what you are really paying for is the entire future profits of the company discounted to reflect the fact that you cannot enjoy these profits today but must wait for their generation at some future date.

However, the medium of such investment activity is normally financial securities – stocks and bonds being the most obvious and prolific – which are merely ways of scattering the ownership of a company across many different investors, each of whom owns a portion of the company’s future profits4. However these securities are themselves traded on an independent market and markets, as we know, are formed by the demand of buyers and the supply of sellers. There is, therefore, a supply and demand for ownership of these “pieces” of companies. This supply and demand is driven by investors and their views of whether a particular company will best serve the needs of consumers. It follows, therefore, that if a great number of investors believe that a company will be particularly illustrious and successful in performing this function the demand for its securities will be very high relative to their supply. If however, the investors believe the contrary – that the company is wasteful and has little or no prospect of earning a profit – there will be an eager rush to sell its shares and hence demand will be very low relative to supply. This is what, proximately, causes some share prices to be “high” and others “low” – the opinion of investors of whether the company concerned will generate future profits. Notice that this market operates entirely independently of the operations of the company itself; although the share price should, theoretically, follow the success of the company, they can and do diverge because investors change their minds as to the ability of the company to generate future profits. All this proves is that the investment operation is speculative – that it is looking forward to a future state that is uncertain and that this future state may turn out very differently from that which was hypothesised5.

There is, therefore, an investors’ market where people will buy not consumer goods like meat, bread or coffee but securities in companies. But this market operates just like the consumers’ market and it is wholly based on the supply and demand for the products that are traded. If coffee is suddenly demanded very highly then in step the speculators – caring not of the reasons for the consumers’ desires – who buy, and hence bid up the prices of, the factors of coffee production to ensure that less urgent needs are choked off from their use in order to ensure that they can be devoted to this very pressing need of the consumers that has emerged. But exactly the same happens on the market for securities. In just the same way that consumer demand for coffee might rise because they believe it to be delicious and nutritious, so too at any one time investors might increase their demand for shares of Company A on the belief that A has a strong prospect of earning future profits.

In, therefore, steps our financial speculator. In just the same way as the speculator in consumer products has to speculate on the demand and supply of these products, so too does the financial speculator speculate on the demand and supply – of the investors – for financial securities. In just the same way that the café cares not for the underlying qualities of coffee but only for the fact that it is in heavy demand, so too does the financial speculator care little for the qualitative prospects of the company from which the security is derived to earn future profits; he cares simply for the security’s supply and demand driven by investors. He will buy the security if he believes that, at this price level, demand for the security outstrips supply leading to an inevitable price rise; in other words, if investors who believe that the company will generate good future profits outnumber those investors who do not. He will sell the security when it reaches a price level where supply and demand are in equilibrium, or he will short sell if he believes that the supply of the security is in excess of its demand, i.e. if investors who believe the company will generate good future profits are outnumbered by those who do not.

It follows, therefore, that the majority of investors may be totally erroneous as to their opinions of the company; they may all want to buy a complete turkey of a company in the mistaken belief that it will be handsomely profitable, or, alternatively, they may sell the golden goose. The financial speculator cares not about whether these companies really have an underlying ability or lack thereof to generate future profits; his focus is entirely on whether the investors believe that they do and the consequential supply and demand that is generated for the securities6.

What economic benefits does such a speculator achieve? More or less they are identical to those of all other speculators. If the speculator predicts that demand for a security will be very high then not all of the investors who wish to buy can do so at the current price. The speculator’s additional buying will therefore cause a price rise that occurs sooner than it would otherwise have done so. In the same way that bidding up the factors of production diverts their use from less urgent needs, so too will the financial speculator begin to choke off demand from incompetents – not merely dabblers and gamblers or those with insufficient funds to purchase at the higher price but also those who are less certain or have been less scrupulous in forming their belief that the company is a worthwhile investment. The rise in price therefore reserves the supply of the security for the investors whose belief in the company’s prospects to earn returns is so strong and committed that they believe that even a purchase at this higher price is justified and will be covered by these future returns. It is to these people whom the speculator will sell. Conversely, when the speculator believes that supply of a security is in excess of demand – i.e. that the majority of investors believe that the company will not, at this security price, earn a future profit that justifies it – he will short sell it. As not all willing sellers can sell at this high price due to the lack of demand, the speculator’s actions in driving down the price will again choke off the less competent sellers – those who are less certain or have been less scrupulous in forming their belief that the company is a turkey – and the resulting fall in price to where demand is higher means that investors whose belief in the lack of the company’s prospects to earn returns is strong can now find a demand to sell to. It is from these people whom the speculator will buy to cover his short sale and, indeed, his aim – if he is to achieve the highest profit – is to buy from the very last of these investors, when the price movement is necessarily at the lowest it will go.

In sum, therefore, the financial speculator provides the committed investor, the one most dedicated to directing resources to where they are most urgently desired by the consumers, a supply of securities when the latter wishes to buy and a demand for them when he wishes to sell. There is, therefore, no substantive difference between the relationship of a shop with a customer and a financial speculator with an investor. It is merely that the service of the financial speculator, by ensuring that security prices most quickly reflect the underlying supply and demand, is not to directly channel resources to where they are most urgently needed but to facilitate the ability of the investors to do so.

It should be clear that the most lucrative investment operation is one that takes note of this speculative ability. For if one wishes to make the highest profit it pays to combine the two operations – by a) finding those companies that will best meet the needs of consumers and generate the highest profits, and b) whose securities are trading at a price where demand is far in excess of supply and hence are due for an inevitable price rise. It is for this reason that the famous philosophy of value investing – buying the most profitable companies at prices below that at which the investor believes represents their discounted profit stream – is so successful. Indeed, it is analogous to a consumer being able to buy at wholesale rather than retail prices – you are buying the same value but at a lower price hence the differential between the price and your reward is greater. As the first chapter to one introduction to value investing is titled, “Buy Stocks like Steaks…On Sale”7.

Charting, “Gambling” and Asset Bubbles

Let us conclude by laying to rest some additional myths associated with the financial trader. The speculator’s primary tool of price charts and its associated array of mathematical studies that are derivatives of price (used in methods that are collectively known as “technical analysis”) lead the casual observer to declare that all speculators do is follow a few patterns or look at a few studies and then repeat this over and over in order to rake in huge and “unjust” profits. But to assume this is to make the cardinal error of treating human activity like that of unconscious matter, that when any pattern or mathematical progression repeats it signifies a buy or sell signal that, unfailingly, will produce profits. Such nonsense detracts from the central task of the speculator, one that has been stressed over and over in the above – to find imbalances in the relationship between supply and demand. All he is doing, just like any other speculator, is finding the prices where supply and demand are in the largest disequilibrium except that he finds these areas by interpreting price charts. There is nothing technical or mathematical about this process; it is, rather, an entrepreneurial skill just like any other. Every profitable trader knows that there is not a single technical or mathematical study that, taken alone, will yield consistent profitable trading activity; indeed it is the fastest way to run down a trading account. Rather, the speculator learns what supply and demand imbalances tend to look like on a price chart and he trades only in these areas. But he knows that human action is not uniform and repetitive and he does not expect every instance of his analysis to provide the same result. Rather, he condenses his interpretative techniques to a handful of rules that he applies with a probabilistic approach to discovering where supply and demand are most in disequilibrium, risking a small percentage of his funds by stopping out of a trade in cases where he is wrong. The most skilled traders can keep such losses to a minimum to the extent that they simply become a cost of doing business; indeed with proper risk-management skills that ensure his losses are small and his profitable trades are large his interpretative methods may even allow him to make losses on more occasions than he makes profits. But regardless of his precise win/loss ratio recognition of the fact that a trading method does not work one-hundred percent of the time (a point on which all successful traders will agree) proves that there is nothing about trading from charts that can be scientifically or quantatively determined. The only science is in the fact that disequilibrium in supply and demand causes prices to rise or fall; interpreting where these points lie on a price chart is a rare, entrepreneurial skill.

Nor can it be said that financial traders are “gamblers”, that is that their returns are based on pure luck. The point of this essay has been to demonstrate that all market participants are speculators, they all, fundamentally, are doing the same thing regardless of their specific methods and preoccupations, and the economic effects of their actions are always the same. There is, therefore, no way in principle to distinguish one type of speculator from another. If a financial trader is a gambler on rising or falling prices then so is every business, every shop, every carpenter, and every plumber in the world. But even if financial traders or any speculators were simply gamblers then what harm would it do? Every speculator, as we have noted, must one day sell after he has bought. He is not a producer of original supply or final demand, rather he greases the market towards prices where the original suppliers and final demanders are in equilibrium. If he is successful in doing this he sells for a profit; if he is not then he sells for a loss. If the former then he has aided economic efficiency by moving supply and demand towards its equilibrium price, whatever his methods. Consequently he is trusted with more funds on which to make larger and more important speculations in the future. If he loses then it is the opposite – he has harmed discovery of the equilibrium price, but his resources for doing so are limited. If he keeps making losses then very quickly the market will wipe him out and his means for causing ill economic effects are curtailed. However if these losses happen through gambling then the situation is just like that of any speculator who applies faulty methods, whether they are laziness, sloppiness or simply a lack of entrepreneurial talent. There is no way to separate a gambling speculator from one that is simply bad.

Finally, let us consider wild speculative bubbles that, during boom years, inflate away like an aphrodisiac balloon until they finally pop, ushering in a recession or depression following a crash in prices. This is not the place to discuss at length the cause of the business cycle by artificial credit stimulation. But if such artificial stimulation distorts the underlying fundamentals of the economy – by making longer and more roundabout production processes appear more attractive and diverting resources unsustainably into capital projects – then this is not the fault of the speculator. Remember that every speculator is always in the position of having to sell after he buys. He cannot, therefore, affect the overall or average price level of the speculative good. In buying capital goods at the start of the boom, the very ones that he knows will be sucked up by all the freshly created and loaned money that is emerging from the artificially low interest rate environment, he merely moves prices quicker to where they are already heading as a result of all this newly printed money. The boom therefore happens quicker, but it is only in response to the anticipated demand that has been falsely stimulated by credit creation. The same happens at the bust phase – by selling or short selling the speculator simply lays bare the fact that demand and supply, at such inflated prices, cannot continue to be in equilibrium in the absence of continued credit expansion. His action at the peak of the market and on its slide down liquidates the boom’s malinvestments quicker and, uninterrupted, provides a painful but much speedier recovery to a sound and stable economy than otherwise would be the case. Speculation exists to serve the direction of supply and demand in the economy whatever causes this supply and demand to occur on the part of market participants. If the directions of supply and demand are distorted by destructive interventions then their consequences are not the fault of the speculator. Proper blame should be laid at the door of the easy credit policy which still, regardless of the continuing economic malaise since 2008, is the favourite of governments and central banks everywhere.

Conclusion

In sum therefore, it may be said that:

  • All human actions are speculative and therefore everyone is a speculator;
  • That all consumer choices are speculations;
  • That all market participation – buying and selling – is speculative;
  • That speculative activities are beneficial to channelling the scarce resources of the Earth to their most urgent needs and uses by harmonising supply and demand;
  • That it is not possible to distinguish, in principle, between different speculative activities on the market; and that, further, differences between types of speculator usually centre on the fact that a lack of physical change to a good is falsely regarded as a lack of added value;
  • That common myths regarding the nature and alleged destructiveness of financial trading in particular are entirely false.

1 We might also point out that the higher prices of the factors will also be preceded by speculative action for them as well, and investment will also be drawn towards increasing the supply of these factors that is now justified by their increased price. Hence their factors also will increase in price, and so on and so forth right back through the chain of production until prices for all of the factors and their respective finished product approach equilibrium.

2 If this equilibrium is reached oranges will still trade at a premium in London because of these costs.

3 For the avoidance of doubt we are not referring here to the premium placed on present goods vs future goods as a result of the law of time preference; we are discussing here real changes in the supply and demand for a good.

4 Shareholders and bondholders fulfil the same economic function as each other – they both advance investment funds to the company. The difference is that they do so merely on different legal terms and acquire different rights through the respective relationships.

5 Earnings announcements are typical examples of where the share price diverges from the company’s ability to earn future profits. If earnings are good the share prices normally rocket on the news whereas if the are bad they plummet. But today’s earnings have nothing to do with tomorrow’s. If today’s are bad it might be that the company still has the ability to pull itself together and deliver a result tomorrow; or it might really be a turkey and still continue to lose money. If, on the other hand, today’s results are good this might be the best that it ever gets and tomorrow will only generate lower profits or even losses; or it might just be the start of a long and prestigious career of generating truly handsome returns. All of these options are possible yet nearly always investors react as if good news today is good for tomorrow and bad news today is bad for tomorrow.

6 These facts should put an end forever to so-called efficient market hypothesis (EMH). The hypothesis is based upon a misunderstanding of why markets are said to be “efficient”, a term itself that is vague and stifles clarity. Markets are “efficient” because they harmonise the supply and demand for goods through the price mechanism, in other words goods are directed to where they are most highly sought and, a fortiori, their most highly valued ends. But the efficiency of markets has nothing to do with the underlying valuations that drive this supply and demand. These are products of the human mind, the result of desires and choices, and the notion that prices respond “efficiently” to publicly available information suggests that the impact of this information upon such human choice and desire is uniform, predictable and quantifiable. The theory’s weakness is similar to that of a strict adherence to the quantity theory of money in attempting to explain how increases of the supply of money affect the so-called “price level”. Further, the entire reason why profits are earned in an economy is because future valuations are not known, nor are they available in publicly disseminated information; it is, rather, the task of entrepreneurs to bear the risk of predicting them through their understanding of their customers’ sentiments. A million investors, acting on all of the publicly available “information”, may dump the stock of a company that, tomorrow, will earn sky-high profits. The one investor who goes against this grain and buys all of the sold stock is the person who reaps the “excess” reward that EMH states is impossible or at least unlikely.

7 Browne, Christopher H, The Little Book of Value Investing.

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