Home > Commodities, Economic Fallacy, Economics, Economy, Epistemology, Financial Crisis, Liberalism, Speculation > Economic Fallacy II: Speculation is Harmful?

Economic Fallacy II: Speculation is Harmful?

Apart from outright naval blockade or sieges there has probably been hardly another operation considered as deadly and therefore been at times revenged than what is deemed “profiteeringspeculation. The idea to many is that speculation robs honest people of their livelihood. Alleged speculators have been tortured, hanged, disenfranchised, robbed, denigrated, banned, imprisoned, scandalised and impoverished throughout human history and still today economic policy is rife with discussions on how to curb “illicit” forms of speculation.

(See more statistical material in our References section!)


Notice: this is to educate investors, it is not investment advice, as lined out in the Legal Disclaimer.


Whenever words or (alleged) actions trigger such violent reactions some sober analysis is in order. After all, the United States could not have been the biggest slave-holder for so long if they had not divided humanity into two classes, one whom the “all men are born equal” applied to and the other who could be enslaved despite their humanity and many of whose descendants to this day have less than a fair share of the nation’s welfare.

Words are a powerful thing indeed. All past wars have ended but still rage on in cracker-barrel discussions (which not too seldom lead to the next war and so on). So let’s speculate a little about a world with and without speculation!

What is speculation?

For the course of our inquiry, speculation shall be deemed that economic activity in which a “speculator” (by and large) buys in the hope of later selling at a higher price while without that motive he/she would have chosen a different economic activity.

We already get an inkling that Wal-Mart as well as the neighbour with his garage sale may be in with these evil speculators – indeed it appears as if a demarcation line can not easily be drawn between the activities of an “honest” merchant who buys wholesale to stack it for you to later buy retail and the activity of people who … ah, how shall I put it? who – buy and sell? Probably all trade is speculation? And what about decent manufacturing? Stamp collecting? Horse breeding? Any exceptions?

Now, if that is all there were to it, then each college student is a kind of speculator who now “buys” knowledge only to later sell it at a higher price. Profiteering drives the knowledge industry as much as it does the sex industry it appears. So, in true Pol Pot Khmer Rouge fashion or as chiliastic movements time and again proposed, should we skip the studying part and get to work in the rice paddies without further delay?

Obviously, the speculative activity as such may sometimes, with the right ulterior motives, prove quite fruitful not only to the speculator but to society at large. If you lived in suburbia and not your decent well-mannered and well-educated neighbour but some “uneducated bum” had bought that house next door you wouldn’t be pleased. Of c(o)urse, you were a bit on edge when you discovered how prices rose when you decided to buy because all these bank(st)ers with their boni bid up the price of land. However, equally you weren’t so pleased – and that’s why you moved there in the last analysis – when these hooligans at your last place gave your neighbourhood such a bad reputation you had a hard time selling your previous abode below the price you bought it for?

So what then is bad speculation?

While we may all be children a heart probably because of that often we are also recondite spoil-sports. If someone makes money with a clever idea many will begrudge the speculator while if his speculation goes all wrong many rejoice on account of his mischief.

Let’s just look at the

typology of some of the most blatant cases of alleged speculation

that have probably given it its bad reputation and which frame the current prevailing perception that speculation has a tendency “to go too far” and what better remedy to not only revile it but give some teeth to the emotion by thoroughly regulating it?

Type I: The contrarian investor

There’s a market crash, everyone heads for the exit and sells his shares in the vain hope to at least minimise their losses as against waiting till tomorrow. The typical sell-out panic then often is fueled by unmet margin calls and compulsory sell-offs of shares their “owners” wanted to actually hold on to (of course they’re not speculators, they’re poor devils to be pitied – and shouldn’t they be protected against what unfolds now? Moratorium? Loan Modification? Subsidies?). In step some speculators and at a certain stage they start buying. Eventually they even make a profit and now those who lost money are upset at such unfair “luck”.

Have those who find this unfair and had just “lost” their shares (or houses, or bonds, or surprise egg collection …) to this avaricious scum ever contemplated how much further their shares etc. might have fallen if not at some stage someone would have stepped in, risked his money and thus put a safety net under your, the failed previous speculators’ (!), losses?

Actually, those that bought into a rising market needed little courage. If they didn’t trust their broker or financial advisors, they could always take their stock tips from their hair dresser or get a mortgage from her husband, the realtor-cum-mortgage-broke(r) … Doesn’t it take rather tremendous courage to buy up shares that may still be poised to fall a lot farther? Should you not rather bring this to book as having learned the hard way and get on with earning a solid income that you now have learned to invest a bit more prudently? And has it never occurred to anyone that, in order to reap the same relative profit as the reviled speculator all they would have had to do is right at that moment that he bought hold on to their shares (reckless margin financing aside where you might have had no option at the time – but that falls under the “you made your bed so sleep in it” moral). Because any profits as he is now likely to make from there on in an upswing that his actions helped bring about could equally have been yours, had you equally bought back in at that stage.

Ok, maybe some speculators are useful creatures after all, but then what about this other vermin

Type II: The short seller

Short selling is nothing of the sort, sometimes it takes patience and a rather long breath (and nerves). What it means is that you speculate share prices etc. might fall and rather than Type I to wait for the right time to buy (sometimes called “market timing” and the doom of many investor) at the time when prices “can fall no further” this is a more sophisticated animal: he “sells before they fall”, when everyone else still believes they’ll rise or stay where they are at least. Now, this gives us pause: if someone expects prices to fall, thus not entering the market at the time but just waiting on the sidelines he may help you buy at more considerate prices since, had he bid alongside you, you wouldn’t have got such an attractive bargain at the time. No harm done to you yet. It even gets better: now the short seller gets into action. What does he do? At a glance: he sells when you may still want to buy, making shares more affordable for you, although effectively he sells shares he doesn’t have. What seems a miracle and a cheat he cannot actually pull off without your, the share holder’s or buyer’s complicity! He e.g. borrows shares from you and sells them immediately in the market at the current price or rather another uptick thus at that time keeping volatility in check. It has often been alleged that this will drive down prices and of course in theory, if everyone and his wife began short selling (because schizophrenic everyone and his wife lent him all their shares or else he wouldn’t have anything to sell …) on closer inspection, market panics aside, that is next to impossible. Instead what this short selling activity will do is stabilise the market for you, the “bona fide” share holder!

This is how that governor on prices and markets works: You are anyway the guy who believes prices can’t go anywhere but up, right? That’s why you invested, wasn’t it? So what does it matter to you if someone else holds a different view? Lucky you, if that guy contested your buying binge you mightn’t have got in at the lower price that you actually got in! Now if that brainless git asks you to lend him your shares for a nice bundle and guarantees to give them back to you in, say, three month’s time during which period you were so adamant they could only go up and that you no way would yourself have wanted to sell them, then you can only profit from that other guy. Now the short seller sells your shares  – never mind, there’s ample insurance your money is safe, he has to open a margin account, the money will be in escrow and some market-maker will even make up for the difference if shares (as you suspected all the time anyhow) have gone up during these three months and the short seller now has to buy back your borrowed shares at that higher price, wiping out all hope of profit, leaving him to effectively pay … for no shares. Mind you, in that scenario you made the same gain as if you yourself had kept the shares to yourself, i.e. the gain that is due to the pure market appreciation, but thanks to John Shortseller you earned some profit on top of the market appreciation for lending out those fine shares during that time. Moral: in this scenario only you, and you only, gained. Can you complain? Do you begrudge John Shortseller his loss?

On the other hand, let’s say, you were wrong, the market did turn a little sour during these three months. Since you were that “buy and hold” type you wouldn’t have wanted to sell on any account (if you’re true to yourself and not a turncoat, because if you are, you shouldn’t have entered the stock market in the first place). So what happens then? In that case, you buying and holding, hoping against all hope, would have had to eat all your respective losses. In case of you lending during that period of eventual decline, you cut your losses because you still have that fee from the short seller that otherwise you wouldn’t have had. But it gets even better: let’s say, the market has a lot further to fall, and short seller knows that very well. However, him having committed to you that after three months, say, he has to give you back your shares, he, of all people, now has to buy into a falling market, tears in his eyes, to restore your shares to you instantly. Now, what does that mean? It means, that all of a sudden, during a market panic, when all others, including you, my dear prudent investor, would have not even dreamt of buying, John Shortseller (a git, after all, we knew it all along …) has to buy! No matter, if you still are the unreformed buy-and-hold type (then go on holding) – at least you made a handsome profit over your neighbour who didn’t lend out his shares. Or you still can sell now if you feel like it (or lend again to another shortseller). So: lending shares to short sellers is of course not for those who themselves want to be ready to “jump ship” any moment, but whoever feels cocksure his portfolio composition in three months’ time should look exactly like today should most certainly consider befriending a short-seller! You and the market at large could only win!

Type III: The “Naked” Short Seller

Type IV: Derivatives – Weapons of Financial Mass destruction (Warren Buffett)?

Both coming soon …

Still other forms of large-scale speculation

Last but not least: The most money ever being pumped into speculative bubbles is by states’ “affirmative actions” in one way or another; in a sense modern state is the bubble par excellence! Since there is a miraculous multiplier that amplifies any public expenditure, no matter where, no matter what, all “The State” has to do is give Paul money to build a bridge, a Potemkin village or … do nothing even. Now, that’s speculation if ever there was one!

To do that though State has to rob Peter to rob Paul (forgive me, that was premature … to give to Paul – not Ron of course 🙂 ). Obviously Paul will be a better speculator than Peter or else he wouldn’t have magically now gotten the money Peter had originally earned through his speculation (remember grinding through college to reap a speculative reward on education?).

Demoralised, Peter eventually joins Paul in the same queue as Paul to collect the dole. Either because he said “why work?” or else because he can’t find work anymore. Right after Peter meets Paul together they see the inherent flaw in that scheme: Paul’s money shouldn’t have come out of Peter’s pocket and all would have been well! The Copernican Revolution in economics has set in, it came from amidst a queue of the disenfranchised! It’s been said down through the ages that nothing motivates man more than his urge to better his lot; if at the same time he can “love his neighbour as himself” but without extra cost, then he’ll be glad helping out in turning water into wine and even feel good about it (and teetotalers may chose a more harmless object for their multiplier magic, of course).

It started probably with egg-beaters then ice-crushers and it ended (well, almost, we’re not quite through yet) with a better application for rocket-science in economics.

The magical wand then turned away from Peter’s pocket and invented a printing press with which to print money to give to Paul with Peter not being any poorer. And then, of course, the multiplier doesn’t care a bit where that money came from, it’ll magnify it just as faithfully as a long-sighted’s glasses will magnify his eyes without him feeling any pain …

If capital is a measure of wealth and if capital can be expressed in money terms then we just recently grew immensely richer just by creative accounting:

Amount of US Dollars "in circulation" 1913 - present

Amount of US Dollars “in circulation” 1913 – present

Whenever you feel you are the victim of an illusion that you might feel a pinch, come here to watch your growing riches via the automatic update!

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