Markets and Central Banks

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The financial world experienced its equivalent of a major earthquake this month when the Swiss National Bank (SNB), the central bank of Switzerland, made a dramatic and unexpected change in policy. In 2011, concerned by the rapid appreciation of the Swiss Franc and, thus, damage to Switzerland’s exporting industries and commercial banks, the SNB instigated a policy of maintaining a peg with the Euro at 1.20 Francs to the Euro. If ever the price of Euros declined against this mark then the SNB would obligate itself to sell Swiss Francs and accumulate Euros to maintain the parity. This policy therefore created a seemingly impenetrable price floor for the Euro against the Franc. Whenever the Euro declined to the 1.20 area traders could take a sure bet that they could sell Francs and use them to buy Euros (technically referred to as “shorting the Franc”), knowing that the SNB would take action to depreciate the value of the Franc and thus increase the value of the Euros that these traders now held. Indeed, that was precisely what was happening and what was expected on January 15th of this year when many traders had just opened long EUR/CHF positions as the currency pair was hovering around the 1.20 area. In recent months, however, the increasingly lax monetary position of the European Central Bank in order to ward off deflation and sluggish growth in the Eurozone – leading to a QE programme announced on January 22nd – led the SNB to maintain an increasingly expensive policy of depreciation of its own currency that risked fuelling bubbles and malinvestments within its borders. Clearly they were spooked by something as no one seemed to be prepared for the sudden announcement, on January 15th, that the SNB would, with immediate effect, abolish the peg against the Euro and the Franc would again be permitted to fluctuate freely. The market was suddenly awash with sell orders for the Euro and buy orders for the Franc that, within the space of a few minutes following the announcement, the Euro depreciated against the Swiss Franc from about 1.20 to around 0.75 – a dramatic drop of 37.5% – and eventually settling around the 1.00 mark. The movement happened so fast that any liquidity between these two points completely evaporated and anyone hoping for an entry or exit between them was pursuing a lost cause. Needless to say, anybody who owned the Euro against the Franc lost an awful lot of money, with some large institutions, such as Citibank, Barclays and Deutsche Bank, losing tens, if not hundreds, of millions of dollars. Particularly hardest hit, however, was the retail foreign exchange market, which in recent years has seen considerable growth amidst relatively lax regulation. Several of these outlets went bust while the largest, FXCM, had to be bailed out by an investment bank with $300m. Retail traders to whom these institutions cater are those who trade “on margin”, in other words, they borrow money to fund their positions. Thus their own equity amounts to only a proportion of the total cost of any trade, often as small as 0.5%. Therefore, a small movement in favour of any particular trade can lead to large profits, while a small movement in the opposite direction threatens not only to wipe out the client’s capital but to leave them owing money to their broker if the trade continues to sink and is not closed out. If this is the consequence of a small adverse movement, imagine the effects of an extremely large move such as that seen on the 15th. The movement was so sudden that stop losses, the trader’s conventional protection against risk, were useless and FXCM was particularly hard hit, being left with $225m worth of client accounts with negative equity. Needless to say, of course, there were also big winners on the other side, particularly those who were either skilful or fortunate enough to own put options on the Franc against the Euro with a strike price close to the former peg.

Standing aside from this entire calamity, what should the Austro-libertarian make of the situation? Profits and losses are supposed to be the result of superior entrepreneurial judgment in directing scarce resources available to the ends most urgently desired by consumers. Those whose judgements are more accurate than anyone else’s will walk away with profits, those who whose are not will be lumbered with losses. In financial markets, this is manifest in, say, the purchase of a stock which demonstrates the willingness to invest capital in the underlying enterprise and that the enterprise is one which will meet the ends of consumers with its trade; or a speculation in, say, the futures market is an attempt at “price discovery” and to prevent the emergence of false prices that would cause resources to be wasted1. However, the overwhelming fact that was laid bare on January 15th is that entrepreneurial fortunes are not made and lost in the financial markets through correct foresight of the desires of consumers – they are made and lost based on the whim of central banks. People are no longer rewarded for best estimating the desires of consumers but for guessing the motivations of the financial lords and masters sitting on their thrones of paper money. The stock market is no longer a place to rationally allocate resources amongst industries but a place to make bets on monetary policy. Indeed most of the significant shifts in a given stock market are made on days when the relevant central bank makes an important announcement. Those who clap their hands with glee when parasitic “gamblers” burned their hands on the day of the SNB announcement and “got what they deserved” should ask the logically prior question of why the financial markets have become such a casino in the first place. For years, central banks have maintained artificially low interests supported by monetary expansion which have made it profitable to plough funds into assets such as stocks at extraordinarily low cost – buoyed up by the, not unreasonable, belief that central banks will act to correct any dips in asset prices. Indeed with interest rates so low, borrowing money to buy assets has become an almost costless affair. Why should anyone follow other, riskier entrepreneurial ventures when this one has almost no chance of failure? Indeed, the SNB’s own commitment to maintain the peg seemed to promise free profit to anyone wishing to buy Euros and sell Francs near the peg, knowing full well that the SNB would be doing the same and hence buoying the value of the Euro against the Franc. Given that central banks have been creating fortunes for years it should come as no surprise when they take them away again, albeit in one, spectacular blow.

There is, however, a glimmer of light that has emerged from the situation – that the reputation of central banks and their pronouncements may have received lasting damage. First, the fact that the SNB reiterated, in no uncertain terms, its policy to maintain the peg a mere month before it was removed indicates that what central banks say cannot be trusted or taken as gospel. Second, the fact that it did so abandon its policy reveals the fact that these institutions do not possess the omnipotence and invincibility that they have led us to believe. In the long run, central banks cannot outwit reality and the market cannot be fought. By accumulating depreciating Euro assets at the same time as appreciating Franc liabilities the SNB was driving itself towards bankruptcy with a ludicrously expensive policy. Perhaps, therefore, the sudden realisation that the emperor has no clothes will cause bankers, economists, investors and speculators to look at central banks with a more critical and sceptical eye. May be there will then be a chance that the fatality of the pursuits of the more important central banks, such as the US Federal Reserve, will achieve widespread realisation.

View the video version of this post.

1DuncanWhitmore, Speculation, duncanwhitmore.com

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Land and Natural Resources Part Two – Trade and Exchange

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In part one of this two-part series of essays we explored the utility, value, profits and losses that are associated with a single human’s action in relation to land and natural resources. In this second part we will now turn to a consideration of the same in a world where there are multiple humans and the economy is a complex one of trade and exchange of these resources.

Land Settlement in the Complex Economy

Where we have a world of many humans each of them are, at birth, in the same position as our lone human at his birth. They are gifted their own bodies, their standing room and a set of free goods that they do not need to make the object of their action in order to derive utility from. Every action thereafter will be taken at a cost with the object of receiving a gain that will outweigh that cost. To reiterate again these costs and gains must be estimated in advance and so every action is only speculative; there is no certainty that an action will, in fact, yield a gain. In a world of trade and exchange land and its product will trade for money and so these gains and costs will, likewise, be estimated not in terms of land’s physical product but in terms of the money that they will fetch in exchange. Now, therefore, leaving aside mental appreciations such as aesthetics or personal value attached to specific areas of land such as one’s home, we are not talking about merely psychic profits and losses but the actual revenue and outflow of money from operations with natural resources. In other words, how can one make money from using natural resources and how can we categorise the components of this income?

The first, if seemingly trite, observation concerning an unsettled plot of land is that no one has estimated the land as being valuable. In other words no one yet believes that the revenue to be gained from settling this land will outweigh the cost of doing so. Existing settlements or other prospects are deemed to be more valuable than settling the plot in question. The prices of the scarce resources that will be devoted towards settling the plot are being bid up by other potential uses and people estimate that the yield from the land will not be sufficient to cover these costs. Where, therefore, one human decides to settle land it will be because he, uniquely, decides that this land will, in fact, yield a definite gain and that everyone else is in error in leaving the land fallow. Let us again take the example of Plot A, demonstrating now the gains and costs not in terms of physical product but in terms of money. There are only three possibilities:

  1. Plot A will make a profit;
  2. Plot A will break even;
  3. Plot A will make a loss.

Let us examine each of these possibilities in turn, assuming again that the prevailing rate of interest will apply a 10% discount to the gross yield in each year. In scenario 1, we will take the gross yield to be £200K per year with the costs amounting to £100K per year. We can illustrate the net gain as follows in Figure A:

Figure A

Year      Gross Yield        Costs                Gross Gain        (Discount)          Net

1          £200K               £100K               £100K               (£10K)              £90K

2          £200K               £100K               £100K               (£20K)              £80K

3          £200K               £100K               £100K               (£30K)              £70K

4          £200K               £100K               £100K               (£40K)              £60K

5          £200K               £100K               £100K               (£50K)              £50K

6          £200K               £100K               £100K               (£60K)              £40K

7          £200K               £100K               £100K               (£70K)              £30K

8          £200K               £100K               £100K               (£80K)              £20K

9          £200K               £100K               £100K               (£90K)              £10K

10         £200K               £100K               £100K               (£100K)            £0K

The result of this has been a net profit for the land settlor. The land has actually turned out to yield more monetary income than was estimated by everyone else. In other words, everybody else was incorrect in estimating that the land would not produce an end that is more highly valued than some alternative. Rather, the product of the land is more highly valued than other ends to which the scarce factors of production could have been allocated and this value will be imputed back to the land itself so we can say that the land will have a capitalised value equal to the sum of the final column which, in this instance, is £450K. We will return to this again shortly but before that we shall examine scenarios two and three. In the former, it should be obvious that there will be no net gain at all. Let us illustrate this by assuming that the land will still yield £200K per year but now costs have risen to an equal amount:

Figure B

Year      Gross Yield        Costs                Gross Gain        (Discount)          Net

1          £200K               £200K               £0K                   (£0K)                £0K

2          £200K               £200K               £0K                   (£0K)                £0K

3          £200K               £200K               £0K                   (£0K)                £0K

4          £200K               £200K               £0K                   (£0K)                £0K

5          £200K               £200K               £0K                   (£0K)                £0K

6          £200K               £200K               £0K                   (£0K)                £0K

7          £200K               £200K               £0K                   (£0K)                £0K

8          £200K               £200K               £0K                   (£0K)                £0K

9          £200K               £200K               £0K                   (£0K)                £0K

10         £200K               £200K               £0K                   (£0K)               £0K

In this instance what is produced is exactly what is paid out in costs and there was, therefore, absolutely no point in settling the land. While there has not been a loss and the settlor is not in any worse position than he was before, there has also been no gain and the entire operation has been pointless. What about scenario three? Now let’s assume that costs remain at £200K but that now the land only yields £100K of gross income:

Figure C

Year      Gross Yield        Costs                Gross Gain        (Discount)          Net

1          £100K               £200K               (£100K)             £10K                 (£90K)

2          £100K               £200K               (£100K)             £20K                 (£80K)

3          £100K               £200K               (£100K)             £30K                 (£70K)

4          £100K               £200K               (£100K)             £40K                 (£60K)

5          £100K               £200K               (£100K)             £50K                 (£50K)

6          £100K               £200K               (£100K)             £60K                 (£40K)

7          £100K               £200K               (£100K)             £70K                 (£30K)

8          £100K               £200K               (£100K)             £80K                 (£20K)

9          £100K               £200K               (£100K)             £90K                 (£10K)

10         £100K               £200K               (£100K)             £100K              (£0K)

Here the settlement was entirely erroneous and will result in year after year of net losses for the settlor. He estimated incorrectly that the yield from the land would be sufficient to cover the costs and, in fact, there were more valuable uses to which these costs could have been devoted. The entire operation has been a waste and the land will simply be abandoned1.

Let us now turn back to scenario one where the land yielded a profit. We noted that the settlor realises a gain upon the realisation that the land will produce a yield the value of which exceeds that of its costs. Once again, as in part one, we must emphasise that this gain is earned not by the “productivity of the land” or its “natural powers”. The land was only doing that which it is under the orders of the laws of physics to do. Rather the earnings, the net income, are wholly the reward of the decision of the settlor to turn that land into productive use, a decision that resulted from his judgment that the land would yield more than its costs, an outcome that was, furthermore, clouded with uncertainty. Everyone else was free to make the same decision and to settle the land first but nobody did. To the extent, therefore, that a person earns a net income from productive use on the land it is only because this person, uniquely, has realised that devoting scarce resources to its settlement and use will yield a stream of utility that is more valuable to consumers than that which existed before. It was his decision that created the increase in value with the resulting flow of productive services, and it is to this aspect that the net income flows.

If this is doubted then we should consider the situation of the evenly rotating economy where all revenues equal cost. In other words there is trade and activity but all the utility of what is received from an action equals exactly the utility of that which is foregone. So if the produce of land yields £200K per year then the landowner will have to pay precisely £200K per year in costs2. If this was the way the world worked then it should be clear that there is no room at all for uncertainty and for decision making. If it is certain that there is no realisation of value, that nothing could ever be made better, then there is no premium to be put on the making of judgments that results in decisions. Net income disappears precisely because there is no need for these aspects. It is only because we live in a world where things can be made better and that this betterment is shrouded in uncertainty that a judgment must be exercised in order to realise it. Good judgments that direct the scarce resources available to a stream of utility that is more preferable than that given up are rewarded with net income. Bad judgments which waste those resources on ends that are not preferred are penalised with losses.

What about, for the sake of completion, a world where things could be made better but that the improvement is certain? That if we made a decision we would know for sure that the outcome would exactly be as intended so that, in other words, everyone’s judgment would exactly predict what would happen. If this was so then everyone’s judgment and everyone’s decisions would be exactly the same. A person can only profit from a decision because everyone else has underestimated the value of the yield from a productive activity, this underestimation resulting in an underbidding for the productive resources that are devoted to that activity. If, however, everyone knew the outcome then there would be no underbidding at all and all costs of production would be bid up fully to the height of the revenue of the resulting product. Hence, there would be no net income.

Therefore our conclusion can only be that the realisation of value is a product of superior human judgment.

Going back to our landowner does he now realise a constant, year on year net income from his ownership of the land? Unfortunately for him he does not. For the £450K worth of net income, representing the capitalised value of the land, is was he earns now and correspondingly takes its place in his rank of values now. It must therefore be ranked alongside other actions which could be more or less valuable now and while he hangs onto the land he always bears the opportunity cost of foregoing other actions. In the case of our lone human in part one this was the result of having to decide whether to continue to produce on the current plot of land or whether to stop and move to an alternative piece of land. In the complex economy, however, the decision that must constantly be assessed and remade is whether to hang onto the land or to sell it to a purchaser. Let us examine the ramifications of this necessity.

Trade of Land

In the first place, let us assume that the net present value of the land – £450K – is not only correct but that also all entrepreneurs know that it is correct and that this is certain. In other words the precise yields from and costs of production on the land are as they are in Figure A above and everyone knows that there will be no deviation from this schedule. What this means is that the purchase price will be bid up to exactly this net present value – £450K – with all potential suitors offering not a penny more and not a penny less. The decision for the landowner is a very simple one – to carry on with production of the land and wait for the fruits of its productivity; or to sell and to accept the present value of this future yield now in cash. The result of this is to impose upon our landowner an opportunity cost that completely wipes out any continuing net gains in income. As he can take the present value of the yield in cash the foregoing of this opportunity through holding onto the land will leave him only with interest from the future yields, i.e. the difference in value of the future yields when they mature and the capitalised value of the land now.

In reality, however, the situation is much different. Rather than everyone knowing the future yields of land they constantly have to be estimated. As we said in part one there are at least four factors that affect this:

a)     Direct costs of farming a plot will change from year after year and must be estimated in advance of their occurrence;

b)     Opportunity costs will change from year after year and, likewise, must be estimated;

c)      The gross yield of a plot of land is not certain in advance; rather, factors such as the weather, seed quality and soil deterioration will intervene;

d)     The discount to be applied to future gains is dependent upon the individual’s time preference rate which is subject to change.

To this we may add one more:

e)     The precise end to which the land is devoted also has to be decided. Should it be used for farming, for the building of a factory, or for building houses? Which of these streams of utility is most valuable to the customers who will provide the revenue?

Every entrepreneur, therefore, including the present land owner must constantly assess and estimate the effect on the productivity of the land by these aspects and this list is not necessarily exhaustive. Having estimated the future yield, each entrepreneur will discount it to a net present value resulting in a price that he is willing to pay for the land now3. Let us look at the mechanics of this fact in situations that lead to a profitable outcome for our landowner. Let’s say that there are three entrepreneurs, A, B and C, of whom our current landowner is entrepreneur A. Each engages in his estimation and calculates the following net present values of the land:

A        £450K

B        £350K

C        £250K

In this instance every other entrepreneur estimates the net present value of the land as being lower than the estimate of A. As A estimates that there is more to be gained from holding onto the land and selling its produce at a later period in time than from selling the land now then he will refuse to sell the land to the highest bidder which is B. If A is correct and the land yields a produce that is more than the estimate of the next highest bidding entrepreneur (let’s say that A’s estimate is precisely correct) then what is the analysis of A’s income? As his opportunity cost was to sell the land for £350K and earn interest on this sum, his actual outcome has been to hold onto the land and earn interest on a sum of £450K. The difference between these two will therefore form a net income – an income that A received solely because he estimated the produce of the land as being higher than that of rival entrepreneurs. Examining each of our criteria a) through to e) above he could have done this a number of ways and, in practice, a combination of them will always be active:

a)     A more accurately estimated the costs of farming the land as being lower than the estimates of B or C; or the methods that A chose in farming the land were less costly than those that B or C would have employed. A’s economy therefore conserved scarce resources to be released for employment towards the fulfilment of other ends.

b)     A accurately estimated that the other opportunities available to him would yield a lower (if any) net income than holding onto the land;

c)      A more accurately predicted the conditions of farming than B or C; the latter might have erroneously predicted more unfavourable farming conditions which led to their lower estimates;

d)     This is a little more complex and will be examined when we discuss land hoarding and speculation (below). Suffice it to say that A may have more accurately estimated the future societal rate of time preference than B or C and hence the discount to be applied to the future yields;

e)     And finally, A might have devoted the land to an end that is more valuable in the eyes of consumers than B or C would have done and thus the consumers were willing to pay a higher amount for its produce than for the produce that B or C might have churned out from the same land4.

Let us say that having witnessed A’s burst of productivity, B and C revise their estimations of the land’s capabilities. For argument’s sake, A maintains his estimate at the previous level:

A        £450K

B        £550K

C        £350K

Here what should be clear is that A now has the opportunity to sell the land for a net present value that is greater than his estimate of the same. He believes that B has overestimated its productivity and will incur a loss if he purchases for that sum. A therefore cashes in by selling to B and earns interest on the sum of £550K. To his horror, however, B finds that the land only yields a present value of £450K and hence he earns interest on this lower sum. It would have been better for B to have foregone the purchase and held onto the cash, earning interest on £550K instead of £450K. The difference between these two therefore represents B’s loss and A’s profit. The loss of B has accrued to a bad decision, a decision to devote the scarce resources available to an end that was less productive than that estimated. The reader can examine our criteria a) – e) above in order to speculate upon the source of B’s error, but the important point is this: where there is a net income it results from diverting the scarce resources to an end more highly valued than that estimated by other entrepreneurs. A loss is made when resources are devoted to an end that is less highly valued than that estimated by the same. Good decisions and beneficial use of scarce resources therefore yield a reward – a net income, a profit. Bad decisions and the waste of resources are punished with losses. Net income therefore flows to good decision-making ability and it is this ability alone – not any productive power of the land or any virtue of its ownership – that commands a premium in the marketplace5.

Now we shall turn to situations in which A’s decisions make a loss. Let us return to the first set of estimations:

A        £450K

B        £350K

C        £250K

A, obviously, will again choose to hold onto the land. But let’s say that in this scenario the land only yields £300K’s worth of income. It would have been better to have sold to B and made a presently valued profit of £50K rather than hold onto to the land and lose that opportunity. A’s decision was erroneous and this error was met with a loss. What about the second set of valuations?

A        £450K

B        £550K

C        £350K

Again A will sell to B in this scenario. A thinks that B is a fool in this scenario for thinking that he (B) can ever ring out £550K’s worth of productivity from the land and A congratulates himself for having made a handsome profit. But what if the land actually yields a presently valued income of £650K? In this instance, therefore, it would have been better for A to have held onto the land and carried on production. Instead he sold it and the passing up of this opportunity imposes a loss upon him.

What we realise, therefore, is that all present and prospective landowners constantly bear the burden of having to assess the future income from land. Present landowners have to determine whether the future income will outweigh the purchase prices offered by prospective buyers. The latter have to determine whether they can offer a purchase price that is outweighed by the future income. Those that make the most accurate decisions in this challenge are those that devote the scarce resources available to their most highly valued ends. They took the decision to direct their resources in this way in the face of uncertainty while nobody else did. The result is a net profit.

We should also add here that good decisions and good decision-making ability are determined relatively not absolutely – the profitable entrepreneur only has to be more accurate than the next entrepreneur. For example, let’s say that the land would yield a net present income of £650K and the following entrepreneurs estimate it as follows:

A        £450K

B        £350K

C        £250K

In this case it is obvious that A will hold onto the land and earn a net income when the yield of the land turns out to be worth a present value of £650K. But what if the estimations were as follows?

A        £450K (same as before)

B        £550K

C        £250K (same as before)

Here A will make the choice to sell to B. Yet even though his choice was derived from the same estimation as in the previous scenario, he now incurs a loss as it would have been better for him to have held onto the land and earn interest on £650K than to have taken £550K in cash. Looking at that same scenario from the buyer’s perspective, B now earns the profit. But what if there was a third set of valuations as follows?

A        £450K (same as before)

B        £550K (same as before)

C        £600K

Now, the profit maker is C. Therefore, even though the judgments that underpinned the decisions of A and B remained constant, the entry of a more accurate entrepreneur meant that the latter earned the profit and they did not. It is, therefore, the most relatively accurate decision in directing scarce resources to their ends that is rewarded. Clearly the same will also be true from the loss-maker’s point of view – a judgment that once was loss-making will become profitable if other entrepreneurs lose their accurate foresight.

Profit, therefore, can only be made when a person renders a valuable service that no one else is able to do. If entrepreneurial foresight becomes more prevalent and accurate its supply increases and, just like any other good, as supply increases then, all else being equal, the price it can command must diminish. If a piece of land yields £650K per year and the most accurate prospective purchaser bids £450K for it that he will earn a net present income of £200K. If, however, the market is suddenly flooded with entrepreneurial talent then each entrepreneur will bid up the land successively towards its mark of £650K. If an entrepreneur would bid £630K for the land then there is a chance for another, more accurate one, to bid, say, £640K. But the entry of a further, still more accurate entrepreneur could raise the purchase price to £645K with profit diminishing to a mere £5K. The extension of this situation would obviously be where every entrepreneur values the land exactly correctly and everyone would bid precisely £650K for it, with any chance of net income disappearing entirely. The existence of net income is therefore negatively correlated with the prevalence of good decision-making ability and as soon as the latter is abundant it ceases to command a high premium and profit comes close to disappearing.

In part one we questioned whether it was possible for luck to influence a person’s net gain. Could, for example, one buy or sell a piece of land having absolutely no idea whether it will yield a net income ahead of the purchase price? Or, alternatively, could one sell a piece of land without a single clue as to whether he is selling it for more than it is worth? In other words couldn’t someone just yield a profit by gambling rather than through any special entrepreneurial talent? If one makes a net income on these occasions then it states one of two things. First, as we said in part one, to consign one’s fate to luck is itself a decision and to the extent that it is more profitable than a carefully considered decision then it is the best decision. Secondly, if one makes a profit from gambling then it is still the case that resources were directed to an end that was more highly valued by consumers than that estimated by other entrepreneurs. In short, the gambler’s guess was better than anyone else’s decision and in its absence the economy would be worse off. It is the realisation of value that is rewarded, whatever the method through which it is achieved. It is just that in our world luck plays a very minor role in reaching this goal whereas good decision-making ability is most often needed.

Speculation and Hoarding

With all of this in mind let us now turn our attention to the speculation and hoarding of land. Land owners are often accused of sitting on fallow land and earning year on year profits while this land could be used for the fulfilment of vitally needed ends6. Can we square these facts?

The first question we have to address is why does fallow land have any capitalised value at all? If it isn’t being used for anything then how is it generating any value whatsoever? The answer to this can only be that, in the estimations of entrepreneurs, the land will not yield any valuable utility from a stream of production now but will, rather, yield the same from production that is begun in the future. Say, for example, that if entrepreneurs estimate that additional housing capacity is not required now but will be required in, say, ten years then the land’s ability to meet this end at that point in the future will be imputed back to the land itself and it will trade for a capitalised value. Obviously the discount applied to a utility only taking effect at such a far off point will impose a cumulatively heavy toll, but there would still be a capitalised value. Entrepreneurs therefore have to decide not only what to devote land towards but precisely when to do it and it is the differences of these estimations that permit one to earn a net income from the hoarding of land.

Let us say that A purchases a plot of land now with the intention to hold onto it without development and is able to earn a net income on this operation. There are two aspects to the explanation of this outcome. First, if all entrepreneurs are agreed as to when is the most suitable time to develop the land is then A can only make a profit if he more accurately estimates the value of the yields that result once this time is reached and the land is developed. This is essentially no different from what we discussed above – the only difference is that the first act of production will not be now but at some point in the future. But secondly, if entrepreneurs are not in agreement over when the most suitable time to develop the land is then A can make a profit by more accurately estimating this suitable time. Let’s say, for example, that the five entrepreneurs would develop the land after the respective intervals have elapsed following purchase and their estimations of the present value of the yields are as follows. Let us also assume, for simplicity’s sake, that each is correct in the estimation of what the land would yield after these intervals:

A        5 years         £600K

B        4 years         £500K

C        3 years         £450K

D        2 years         £210K

E        1 year           £130K

What this means is that E believes that the most productive use of the land will arrive after only one year and that he won’t, therefore, gain more than a present value of £130K by waiting either longer or shorter. D believes that two years is the correct period to wait and any longer or shorter will never achieve as high an income as £210K, presently valued. And so on for C, B and A. The latter, however, is the most accurate and he is the one who will purchase the land (in this case, offering only slightly more than the discounted value of B’s estimate in order to price B out of the market) and he will earn a profit. The effect of A’s action is to withhold the land from development that would otherwise occur too early and thus its direction to an end that is less valuable to consumers is prevented; rather the land is released for development right at the precise time when it is needed for fulfilling the most pressing end. A of course might be “incorrect” in an absolute sense – perhaps had he waited another year still (so six years in total) the land might have yielded a present value of £700K. But as the relatively most accurate entrepreneur he is the one who yielded the profit. Had another person, F, come along and bid £650K then A would not have earned that profit.

Related to this is the height of the societal time preference rate which determines the interest rate. As we said earlier, all future utility from land is discounted according to the prevailing rate of interest. But this too is subject to fluctuation and must be estimated, a point we noted earlier. If time preference lowers then the discount to be applied to future yields of land will diminish and hence the capitalised value of land will rise. On the other hand if time preference rises then the discount will be increased and the capitalised value of land will fall, its promise of future utility being less valuable to consumers. In practice this phenomenon tends to go hand in hand with the fact that land may yield its most valuable end not now but sometime in the future. For land is the ultimate remote good out of which capital goods must be furnished and increased demand for it is almost synonymous with a lowering of the societal time preference rate and a desire to engage in more roundabout methods of production and the creation of economic growth. The estimation, therefore, by entrepreneurs that land will yield a more valuable use not now but in the future also translates into estimating that the societal rate of time preference will be lower.

The allocation of resources across time is also one of the most difficult activities which must be faced by the present landowner, let alone a prospective purchaser. A failure to estimate how much to produce and when to do so has the potential to cause serious losses. The capitalised value of a copper mine, for example, will, as we know, represent the discounted value of all of the future copper that will be extracted from that mine. The choice of how much copper to mine this year is made not only in the face of current costs such as labour, equipment etc. but also the mine owner must consider the fact that any extraction of copper now will mean that there is less copper to be had in the future. If the mine owner extracts copper now then this will cause a write down in the capitalised value of the land as, the copper having been extracted, a portion of it is no longer there to provide for future utility. Whether or not the mine owner successfully allocates copper to the present or to the future depends on the relationship of the revenue from selling copper now on the one hand to the height of the write down on the other. If, having accounted for all other costs, the revenue he receives from selling a portion of the copper today is higher than the write down then this means that the present value of copper sold has a higher value than the same copper would have done had it been left under the ground. Therefore the quantity of copper that the mine owner brought to market was in line with the preferences of consumers and copper was not wasted by being mined too soon. On the other hand, if the value of the write down is higher than the revenue that is received then this means that the copper that is brought to market would have had a higher present value had it been left under the ground to be preserved for a future use. The copper was brought to market and supplied too early and consumers were not willing to devote it to an end today that is more valuable than an end at some point in the future. In short, the copper has been wasted and the resulting loss will penalise the mine owner for this oversight. It is for this reason why capitalism and free exchange provides the best method of conserving resources as the profit and loss system entices entrepreneurs to deploy them precisely when they can meet their most valuable ends.

Taxation of Land

It follows from the analysis in both parts of this series of essays that any attempt by the government to tax the proceeds from land must fall upon one of the three streams of income:

  1. Costs;
  2. Interest;
  3. Entrepreneurial Profit and Loss.

If costs are the target then clearly this just raises the cost per unit of productivity from the land. Within this category will fall all taxes on labour, direct taxes on the costs such as sales taxes, and the taxes that must be borne by suppliers. If, though, interest is the target then this has the effect of increasing the discount from future yields of land. The relative attractiveness of future goods will therefore decline and so too will any engagement in roundabout methods of production that lead to economic growth. Finally, a tax on entrepreneurial profit and loss will penalise the decision-making ability that directs resources to their most highly valued ends. There will, therefore be relatively less inclination to seek out the most valuable ends coupled with relatively more wasting of land as the lack of scrupulousness means that the land ends up being devoted to less urgent ends7.

All taxation on land will simply magnify the costs and reduce the gains. But it is important to stress its effect on our third category of income above, which relates to the entrepreneurial aspect of land ownership. The purpose of the analysis in these two essays has been to demonstrate that regardless of any natural qualities of the land or resource in question every decision and every action – even just holding onto the land – entails a cost that may outweigh its gain. Net gains from land ownership can only be had by demonstrating a relative entrepreneurial talent. They cannot be gained simply by owning land and sitting on one’s backside – there is no category of “unearned” or free income from land ownership that is ripe for taxation and there is no form of taxation that will be neutral on productivity.

At the beginning of part one, we stated that every action has a cost and a gain, the magnitude of each being uncertain. The only free or unearned “income” that a person ever has is his own body and standing room at the moment that he is born. Not only did we indicate in part one that these cannot be considered as “gains” as such but if one is adamant that unearned income should be taxed away then it follows that the only logical proposal to enact that policy is to tax birth. Is any advocate of the taxation of unearned income expecting to be able to propose such levy and, at the same time, to be taken seriously?

Conclusion

What we have sought to demonstrate in this two part series of essays is how an acting human can realise utility, gains, benefits, profits, losses and value from his actions in relation to land, including its use and its trade. We have concluded that the gross yield is directed to three sources – compensation for costs, interest, and entrepreneurial profit and loss. Finally we concluded that attempt to levy a tax on any one of these must have the effect of raising costs and decreasing gains, leading to a relative wasting of land.

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1Alternatively, if the landowner was locked into the operation and had to suffer the repeated losses, the only way he could escape would be to transfer the land to someone else. But who would want to do this? Who would want to take on the burden of a loss-bearing piece of land? The only way that it could happen is if the current land owner was to compensate the purchaser for the future losses – in other words he would have to pay someone the net present value of each year’s loss, the sum of which is that of the last column in figure C – £450K. The interest earned on this sum will compensate the new landowner for the maturity value of the losses (£100K) as each year comes round. This situation is not unusual if you consider the possibility of an enthusiastic entrepreneur taking on burdensome and lengthy obligations to third parties in relation to the operation on the land.

2In most descriptions of the evenly rotating economy there would still be discounting as the costs are incurred at a period of time before the vending of the final product. Indeed one of the advantages of this imaginary construction is that it is able to explain the phenomenon of interest as being distinct from entrepreneurial profit and loss. If the land yields £200K then, applying a discount rate of 10% per annum, costs that are incurred one year earlier will amount to £180K.

3For the sake of simplicity we will ignore the effects upon price of bartering and assume that each purchaser would pay a purchase price equal to his valuation of the land.

4It might also be the case, of course, that A is simply a more productive labourer than B or C and can farm more produce per acre. But any gain in income from this aspect accrues not to A’s entrepreneurial decision-making ability but rather to the remuneration for his labour and this additional income would be categorised in the “costs” column of an analysis of the gross income from the land rather than in the “net income” column.

5We are not intending the words “good”, “bad”, “reward” and “punishment” to imply any moral evaluation of an entrepreneur’s actions; rather, the terms should be appreciated only to the extent that people prefer making profits to losses.

6The recent accusations of the leader of the UK Labour Party, Ed Miliband, were of precisely that.

7In practice, taxes on interest and profit and loss amount to the same thing as it is not possible to separate them from an accounting point of view.

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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