Tuesday, October 6, 2015

How Speculation Works and why the Prophets don't Speculate

There's nothing novel about what David Friedman believes about speculation, economists everywhere would give him a thumbs up for the following description. In Chapter 13 of Hidden Order he covers the issue as elegantly as one can.
It is difficult to read either newspapers or history books without occasionally coming across the villainous speculators. Speculators, it sometimes seems, are responsible for all the problems of the world - famines, currency crises, high prices. 
.How Speculation works 
 A speculator buys things when he thinks they are cheap and sells them when he thinks they are expensive. Imagine, for example, that you decide there is going to be a bad harvest this year.You buy grain now, while it is still cheap. If you are right, the harvest is bad, the price of grain goes up, and you sell at a large profit. 
There are several reasons why this way of making a profit gets so much bad press. For one thing, the speculator is profiting by other people's bad fortune, making money from, in Kipling's phrase, "man's belly pinch and need." Of course, the same might be said of farmers, who are usually considered good guys. For another the speculator's purchase of grain tends to drive up the price, making it look as though he is responsible for the scarcity.
But in order to make money, the speculator must sell as well as buy. If he buys when grain is plentiful, he does indeed tend to increase the price then; but if he sells when it is scarce (which is what he wants to do in order to make money), he increases the supply and decreases the price just when the additional grain is most useful. 
The speculator, acting for his own selfish motives, does almost exactly what a benevolent ruler would do. When he foresees a future famine he drives up the current price, encouraging consumers to economize on food (by slaughtering meat animals early, for example, to save their feed for human consumption), to import food from abroad, to produce other kinds of food (go fishing, dry fruit, ...), and in other ways to prepare for the anticipated shortage. He then stores the wheat and distributes it (for a price) at the peak of the famine. Not only does he not cause famines, he prevents them. 
Speculators, if successful, smooth out price movements, buying goods when they are below their long-run price and selling them when they are above it, raising the price toward equilibrium in the one case and lowering it toward equilibrium in the other. They do what governmental "price-stabilization" schemes claim to do - reduce short run fluctuations in prices. In the process, they frequently interfere with such price-stabilization schemes, most of which are fun by producing countries and designed to "stabilize" prices as high as possible.
Knowing this, prophets of bad harvests everywhere should not only believe that they have a financial incentive to speculate, but perhaps even a social obligation to do so. It is curious that predictors of peak-water, peak oil, the beepocalypse, and the rest rarely speculate on the resources they prophesy will be depleted. I believe it has something to do with putting your money where your mouth is, and how cheap talk is so... well cheap. Most importantly, it has to do with the fact that beliefs about stuff far away from you serve a social function. It isn't about finding out what the truth is, it is about bonding with other true believers and delusions of being a prophet of some kind.

It also should cause doubt in their minds because lots of profit seeking people aren't buying the relevant resource. How do we know? Because the price of the resource is still cheap. Colony Collapse Disorder, California draughts, and oil reserve numbers aren't secrets. But people who's money is actually at stake know that there's something wrong with the prophesies based on these "evidences". And they're the ones who's money is on the line. Meanwhile people who saw a documentary online once like to talk a good game... amid conversation of where their hair was styled, and what's with the new Walking Dead Episode.