David R. Henderson  

On Speculation: BEST LETTER EVER

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This is from a letter that Don Boudreaux wrote to the Washington Post:

Have you noticed the enormous increase in greedy speculation in the northeast over the past two days? It's quite something! In advance of hurricane Sandy, consumers are now artificially increasing the scarcity today of the likes of bottled water, canned goods, batteries, and medicines by stocking up on these goods.

And all of this self-interested speculation - done merely in anticipation of staple goods being much more scarce after Sandy strikes than they are today - is applauded and even encouraged by the news media and government leaders!

What gives? Many of the same people who today publicly encourage us to speculate ("Make sure your family has ample supplies of batteries!") are among the loudest critics of speculation at other times and in other markets.

But in fact the oil speculator who, say, buys oil today in anticipation of oil becoming more scarce tomorrow does just what a consumer does today in a supermarket in anticipation of a disruptive storm: both persons usefully transfer resources across time. They both stock up on resources that are today relatively abundant in order to preserve these resources for consumption at a time when they are relatively more scarce (and, hence, more precious). Both persons transfer resources from today - when the consumption of any one bottle of water or gallon of gasoline provides relatively less benefit - to tomorrow when the consumption of that same bottle of water or gallon of gasoline will provide relatively more benefit.

Anticipating the future and taking actions to allocate goods and services from times of relative abundance to times of relatively greater scarcity is an immensely useful activity. And we all perform such speculation whether or not we are popularly identified as "speculators."


It is strange that so many people attack speculators when they're officially called speculators but encourage average people to speculate.

When I teach futures markets and speculation, I often ask the following question:

Imagine you have 4 vehicles, all with large gas tanks. You decide on one day to fill them all, even though you won't use up all the gasoline in less than 1 month. In what sense are you speculating?


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COMMENTS (31 to date)
david writes:

The ability to speculate on oncoming events is directly proportional to one's possession of the relevant amount of free liquidity ('disposable income') to dedicate to it. It is for this reason that some kinds of speculation are accepted and others are unpopular: some kinds of accumulated wealth are not widely regarded as legitimate, and we don't do enough to legitimize their possession.

Bourdeaux realizes, correctly, that the activities are economically identical but then puts down the different reactions to ignorance. But I think people are smarter than that - they realize, albeit without the lingo of the economics-educated, that a speculator armed with personal advantages is performing rent extraction.

We economists merely rigorize this into the notion that quirky things happen in contingent-claims markets when the liquidity of agents correlates with their information of the state.

Doug writes:

Also consider that the shorter the time frame the worse the speculator is viewed. Someone who speculates on an oil shortage in 15 years and invests in energy infrastructure is usually viewed as a "wise businessman". But someone who trains a computer model to identify shortages of the WTI future contract on a 10 second horizon is an "evil high-speed trader."

Most people think it's alright for an investor to make a handsome profit over years or decades (look at Warren Buffet). But if an investment is viewed as paying off too quickly, like buying a week before the hurricane, people think something fishy must be going on.

David R. Henderson writes:

@david
But I think people are smarter than that - they realize, albeit without the lingo of the economics-educated, that a speculator armed with personal advantages is performing rent extraction.
But the people who have the free time to go to a store and stock up do have a personal advantage.
And I'm willing to bet that most of the people stocking up do not, as you and I do, see themselves as speculators.

david writes:

Naturally not: they see it as a value-laden term, not a narrowly technical act of hedging against the future. I think it is worth being interested in why people load it with the values they do.

A question: suppose you know a storm is coming. Are you willing to shout from the rooftops to your neighbours, to act as yourself and head to the store with all speed? To dispel your advantage for free?

Herman writes:

Well, not being an economist, I'm having trouble seeing how this is the same as speculation, other than at the basic level of acting in anticipation of unknown future events. Speculation in the sense that is often criticized is an activity taken purely for profit, absent the need to insure against a risk such as fluctuations in input costs. People are now buying supplies in response to a specific risk, which strikes me as more akin to hedging than speculating.

Alex Godofsky writes:

While I agree with the general sentiment of the OP, the people stocking up on goods in advance of the hurricane are clearly hedging, not speculating.

David R. Henderson writes:

@Herman,
I'm having trouble seeing how this is the same as speculation, other than at the basic level of acting in anticipation of unknown future events. Speculation in the sense that is often criticized is an activity taken purely for profit, absent the need to insure against a risk such as fluctuations in input costs. People are now buying supplies in response to a specific risk, which strikes me as more akin to hedging than speculating.
Speculation is an activity taken purely for profit. This speculation--buying goods for one's own use--is taken purely for the profit known as consumer surplus. There's not a huge difference except that the traditional speculator, if correct, does more of a service to his fellow man.
As for hedging, good point: it's a bit of both.

Tom West writes:

I find this conflation of the term speculation for two rather different activities to be a somewhat annoying word game, in much the same manner that someone who might try to conflate sharp bargaining and actually robbing someone as both "looking out for one's self interest".

In both cases, one could point to the dictionary to bolster one's case, but the reality is that common parlance makes both claims sound a little ridiculous.

So, to be pedantic, stocking up for oneself, while it benefits oneself at the presumed expense of another individual is roughly welfare neutral, while short-term windfall speculation benefits one person at the expense of many others, hence our view of speculation as anti-social with none of the service we normally like to think accompanies profit.

Of course, long term investment can also be called speculation, but once again, it's a word game, and simply because you can find a dictionary to prove one's case would not make it speculation in people's minds or parlance.

jc writes:

The distinction in the minds of average people regarding acceptable vs. unacceptable speculative buying, imho, is "quantity plus purpose": buy what you need and consume vs. buy much more than you need and sell at a markup. The former is prudent, hedging, the latter enriching yourself by screwing people over.

Even careful, logical arguments that convince people to eventually, begrudgingly concede that speculators benefit society don't make people *feel* any better about speculators; the natural (possibly hardwired) tendency to disapprove of those whose motives we judge to be self-serving is just too strong. ("Even if we are better off due to their actions, they're still greedy bastards!")

David R. Henderson writes:

@Tom West and jc,
Neither of you gets speculation. See my comment above. The guy stocking up for himself just helps himself. The traditional speculator, if he's right, helps others too by moving resources from where they are less scarce to where they are more scarce. If you have your old Samuelson text around, read his section on speculation: it's beautiful.

Tom West writes:

Neither of you gets speculation.

Speculation is an activity taken purely for profit. This speculation--buying goods for one's own use--is taken purely for the profit known as consumer surplus.

Except that the traditional speculator is pretty much engaged in trying to capture all the consumer surplus for himself, which is why he's pretty unpopular.

Moreover, in the most egregious cases, the casual speculator provides anti-service by making the items harder to purchase (selling them out of his garage, etc.) while ensuring that his personal surplus is greatly increased. In such cases, he's not only 'hogging' all the welfare increases for himself, but he's also decreasing the overall total welfare!

Now, I'm not disputing that speculators *can* provide value, but that's not what your quote is about. The article seems pretty clear that the author sees no ethical difference between purchasing for oneself and mass purchasing with the intent to resell when the opportunity presents itself. The need to provide a positive service in no way enters the equation (from what I could read), they're still ethically equivalent in his mind.

It's this sentiment that I think most people would disagree with. In times of great crisis, those attempting to increase their own welfare at the expense of all others are not going to be thought well of.

Obviously, this sentiment can catch those who *do* provide value (mostly by bringing more goods in), but that's not what your quote was about (at least by my reading).

David R. Henderson writes:

@Tom West,
You've got it exactly wrong. It's the guy going to the store who tries to get, and succeeds in getting, all the surplus for himself. I would say more, but I really do insist that you read a section of almost any basic econ textbook on this before I discuss it further with you.

Bedarz Iliaci writes:

Though economists dislike it, the intention of the actor is relevant in judging the morality of an act, not merely the consequences.

The speculator intends at profit through the general misery. He would be unhappy if the forecasted disaster fails to occur.

The individual that merely buys for himself or his neighbors would be happy if the disaster fails to occur. He is not intending to profit by general misery.

Tracy W writes:

Tom West: Moreover, in the most egregious cases, the casual speculator provides anti-service by making the items harder to purchase (selling them out of his garage, etc.) while ensuring that his personal surplus is greatly increased.

So what you think we need is more professional speculators in the market, who sell goods in a way convenient to purchase? For example, the owners of the store could speculate on their own account, as professionals, and raise prices in anticipation of a hurricane. They already have a convenient location. Oh, but politically, because many people hate speculators, that's not an option for most professionals, so it does fall to the casual speculator.

Consequently, economic ignorance means that useful services have to be provided in inconvenient ways, by casual participants. Then people complain about the inconvenience, and blame this on the market, when it's caused by government interference.

Except that the traditional speculator is pretty much engaged in trying to capture all the consumer surplus for himself, which is why he's pretty unpopular.

By this logic Marxism should have been pretty unpopular because Marxism has a pretty big thread about workers being paid the value of their labour.
And, as Adam Smith noted, trying to capture all the consumer surplus for oneself is a general impulse amongst humans, he attributes it to landowners, and to skilled tradesmen (through guilds), and to university professors, as well as merchants and speculators.

The reason that speculators are unpopular here is because the other people generally want to capture all the producer and consumer surplus for themselves, so of course they dislike the competition. People are generally inconsistent ethically, the normal view of most of us is: All for me, and as little as possible for everyone else. (There are some individual exceptions, but I can't see any category of people that are any more likely to disagree with this principle, despite my mention of Marxism earlier, capitalists are no better about this on the whole than workers, or retirees).

The article seems pretty clear that the author sees no ethical difference between purchasing for oneself and mass purchasing with the intent to resell when the opportunity presents itself.

Yes, that seems pretty right. Of course, the speculator is the better guy in this particular situation, as they are helping everyone else, not just themselves, but, Tom, remember the advantages of division of labour. Not everyone has the skills or knowledge to be an effective speculator, if someone is say, a great school teacher say, they're doing plenty of good for the rest of humanity in normal times, I don't see that we should expect them to also speculate, at some risk to their own savings, when they're also worried about an enroaching storm. I think you're letting the perfect be the evil of the good here.

Tracy W writes:

David: But I think people are smarter than that - they realize, albeit without the lingo of the economics-educated, that a speculator armed with personal advantages is performing rent extraction.

An interesting assertion. Why do you disagree with the economic argument that a successful speculator is adding value by moving goods from a time and/or place where they are of low value to a time and/or place where they are of high(er) value? Just as a trucker moves goods from a time and/or place where they are of low value to a time and/or place where they are of high(er) value?

And you appear to be implying that using one's "personal advantages" is a bad thing. But surely an economy is more productive when jobs tend to be done by people with personal advantages in performing that job (bearing in mind that everyone has to learn at some point of course and that comparative advantage can mean that even if someone is very skilled at everything they might be better off focusing on doing one thing very well and having less competent people doing other things).

I am really curious as to why you are taking this extremely unusual position.

We economists merely rigorize this into the notion that quirky things happen in contingent-claims markets when the liquidity of agents correlates with their information of the state.

The idea that "quirky things" is a rigorous statement is laughable. As for "merely", the difference between the two statements is so large that your "merely" reminds me of mathematicians use of the word "clearly" (a use which led me to decide that mathematicians are worse liars than used car salesmen). Please spell out how you got from your first statement to this one here, because I can't see the linkage.

Tracy W writes:

@Bedarz Iliaci: Though economists dislike it, the intention of the actor is relevant in judging the morality of an act, not merely the consequences.

Yes, but that doesn't mean that the consequences are unimportant in judging the morality of it. I do think that the people who try to ban speculation do have good intentions, but as Tom West indirectly pointed out, the consequences are that they harm actual people, by shifting speculation from professionals to causal speculators who operate in inconvenient places like out of garages.

And, it is a pretty big consequence morally that if the speculator gets things right, they're helping people generally if the forecasted disaster occurs, while the individual who only looks out for himself or his neighbours has a much more limited effect. I think that easily offsets ethically the relative happiness or misery for the person themself. Particularly as the speculator, being human, might well be happy at escaping the disaster as well. Poeple can have complex feelings.

david writes:

@Tracy W

I don't disagree with that. The speculator is, indeed, adding value. But there is a story - it may have been posted on EconLog - of the entrepreneurs who decided to price-gouge on ice-cubes to a neighbourhood with a brownout, and the residents queuing up to buy ice-cubes cheered as the entrepreneurs were promptly arrested and the ice-cubes melted in the sun. Humans value a lot more than adding value, so to speak, even to adding their own material value.

Please spell out how you got from your first statement to this one here, because I can't see the linkage.

Certainly. Recall that asymmetric information over true values results in no-trade equilibrium: if someone shows up in your store and tries to clear our your inventory with a wad of cash, the rational response is not to sell anything. This gets worse when non-informed traders are operating on low liquidity to begin with. Real-life people resent having to keep suspecting that something is up.

Real life is full of 'noise traders' - people who trade for reasons other than strict maximization of net present value, if only because maximizing net present value all the time is extremely annoying. And the standard EMH result is that informed traders do not merely add the sliver of value by nudging the price toward its true value; they also extract a rent from noise traders.

david writes:

@Tracy W (again)

You need to be cautious about invoking results, e.g., this is wrong:

And, it is a pretty big consequence morally that if the speculator gets things right, they're helping people generally if the forecasted disaster occurs, while the individual who only looks out for himself or his neighbours has a much more limited effect. I think that easily offsets ethically the relative happiness or misery for the person themself. Particularly as the speculator, being human, might well be happy at escaping the disaster as well. Poeple can have complex feelings.

The speculator increases efficiency but he also extracts a pecuniary transfer from non-informed agents; people who don't know what the words "pecuniary transfer" mean can still feel the hit. You need to exercise more caution in invoking economic intuition, particularly outside first-best perfect-information complete-market problems. Again: quirky things happen.

CC writes:

A lot of you seem convinced that a successful speculator captures the entire consumer surplus. This is not right: Even if there's the slightest bit of competition among speculators, specs can only capture a fraction of it.

Having just survived Frankenstorm Sandy, it seems that if Target and hardware stores had been able to even slightly raise the price of flashlights just before a storm, then then they'd generally have an incentive to stock extra flashlights. Instead, it's business (and prices) as usual, and the result is a big box store with literally zero flashlights for sale.

david writes:

Whoops, quoted too much. I do agree on the ethics are complex.

egd writes:

The difference between the storm spectulator and the oil speculator is the lack of perceived asymmetric information in the storm case.

Consider if a meteorologist had advance warning that a storm would hit on Thursday and stocked up on Monday. Then on Tuesday news became available to everyone that a storm would break.

Lots of people would be upset at the guy who stocked up on Monday. But his stocking up on Monday probably signalled the store to bring in more goods, making more goods available before the storm.

Tom West writes:

So what you think we need is more professional speculators in the market, who sell goods in a way convenient to purchase?

Indeed, yes.

Let me relate the one example that occurred to me when we had our great North-East black-out a few years ago. I went to the store to see if I could purchase any flashlights and batteries. There was a pair of fellows with a shopping cart full of exactly that, cleaning out the entire shelf. One helpfully offered to give me a pack of batteries for $20, then $10 when I refused.

Where were they taking them? They'd sell them around their apartment.

I'm trying struggling to figure out how that could be considered even zero-sum for total welfare. At least if the store was raising the price, my vanishing consumer surplus became the store's producer surplus.

As I said, speculation can add value (shifting resources, opening longer, bringing in new resources), but it's by no means a necessity.

The reason that speculators are unpopular here is because the other people generally want to capture all the producer and consumer surplus for themselves, so of course they dislike the competition.

Odd, I find that at times of crisis, people are most often at their most helpful, sharing their surplus for very little reason outside of wanting to be a decent person.

Also, I disagree with the general sentiment. For most services that I use sporadically, if ever, I am trusting the provider to fairly split consumer and producer surplus, because, honestly, I have no idea what jobs should cost. In 30 years, as far as I can tell by knowledge gained later, I've encountered but a single tradesman who attempted to over-charge. Likewise, I've had tradesman refuse compensation because "it was nothing" (half an hour's perilous work and they didn't even give me their names - they did eventually accept some money when I *absolutely* insisted.).

While I am often cynical and assume everyone is trying to maximize personal gain, what hits me time and time again is that in my personal and professional dealings, this is almost never the case, even when there's no reputation at stake.

In my (middle-class, Canadian) personal experience, the vast majority of people simply don't maximize at the expense of anything and everybody. Sure, there's a little zero-sum competition, but in real life, these are almost always modified by how people wish to see themselves.

Tracy W writes:

David: Recall that asymmetric information over true values results in no-trade equilibrium: if someone shows up in your store and tries to clear our your inventory with a wad of cash, the rational response is not to sell anything.

An interesting claim, my own intuition is that the rational response to raise my prices. Which is what we see happening in markets. One doesn't need to know why there's more demand for your products in order to raise prices and/or increase production. This indeed is exactly Hayek's argument as to why in the real world markets are so much more efficient than command-and-control economies - prices by themselves convey information.

Nor do I see what your statements here have to do with what you said previously. You appear to have brought in some more unrelated material instead, rather than explaining the link between your first two statements.

And the standard EMH result is that informed traders do not merely add the sliver of value by nudging the price toward its true value; they also extract a rent from noise traders.

The normal definition of a rent is "a payment for the services of an economic resource which is not necessary as an incentive for its production". Given that it takes some effort to become informed about anything, informed traders should, on average, be making a bit of money from non-informed traders in order to incentivise the informed traders to stay informed.

You need to be cautious about invoking results, e.g., this is wrong:

You need to be more cautious about telling other people that they're wrong. You don't actually point out any mistake in what I said, you just add another point (and a very incomplete one).

The speculator increases efficiency but he also extracts a pecuniary transfer from non-informed agents; people who don't know what the words "pecuniary transfer" mean can still feel the hit.

And the speculator makes a pecuniary transfer to non-informed agents, people who don't know what the words "pecuniary transfer" mean can still benefit from lower prices post disaster compared to the non-speculation situation. So the speculator transfers money from producers to consumers (compared to non-speculation situation). If we bear in mind that many people can't produce (due to poor health or involuntary unemployment or the like) and they tend to be disproportionately poor relative to producers, then the speculator is helping the poor too (while making a profit).

This ties into the basic argument for speculation: the speculator shifts resources to where they are more valuable, which moves prices to be more similar between the two situations. I am surprised that you don't mention this.

You need to exercise more caution in invoking economic intuition

On the contrary, I am perfectly balanced between caution and aggressiveness in my use of economic intuition. :)

Tracy W writes:

Tom West:On the point of the people clearing out the batteries for resale, I am inclined to agree with you that it would be more efficient for the store to raise the prices directly, what I called "professional speculators". (Unless there's some reason that it's difficult for people near their apartment to get to a store, that more than offsets the cost to people who can get to the store). So why doesn't the store raise the price?

As I said, speculation can add value (shifting resources, opening longer, bringing in new resources), but it's by no means a necessity.

Very few things are a necessity in economics. Even in developed countries, where average wages are well above those necessary to supply the necessities of life, people do tend to respond to higher pay (all else being equal) by shifting to those sectors. Economics is typically not about what has to happen but about what does tend to happen. Obviously, for example, speculators can get things wrong and thus shift resources to states with more of a surplus, but if they do that too often they go bust.

Odd, I find that at times of crisis, people are most often at their most helpful, sharing their surplus for very little reason outside of wanting to be a decent person.

True, you are correct. I was thinking of the general case. Like you, as a NZer I find people very helpful in specific situations, but I've also watched strikes repeatedly occur, the NZ ferry workers used to strike every Christmas (ferry is the main transport route between the North Island and the South Island if you're taking a car), as did NZ airline pilots before the Rogernomics reforms, more recently, doctors leave for Australia with higher pay if the medical service doesn't pay enough, rural hospitals struggle to find staff, people do shift jobs for more money, and the vast majority of people think they are underpaid.

And I've watched a lot of election speeches where the campaigning politicans promise goodies to marginal voters. To take one case, in NZ, the health policy analysts think there would be a lot of benefit from funding more glue ear treatments for poor kids, but politicians put the money towards hip replacement operations for retirees.

I think it would be more accurate to say that people are typically nice and generous in specifics, but when dealing with abstracts, they want to maximise what goes to themselves.

Charley Hooper writes:

@Tom West

If you didn't purchase the batteries for even $10 and the speculators successfully sold them for $10 or $20 at their apartment, then those speculators were transferring the batteries to people who valued them more than you did. That's what the market does: transfer resources from low value to high value uses.

If the speculators failed in their attempts to sell the batteries at their apartment, then they were bad speculators and they suffered the cost.

Those speculators could purchase the entire supply of batteries because the store, for whatever reason, didn't or couldn't limit purchases or raise prices. Someone else stepped in--the speculators--to move those resources to higher valued uses.

Glen Smith writes:

Profit is resources earned less resources required. Profit is used to extend one's lifestyle, manage risk, invest or speculate. In this case, they are using profit to manage risk.

Tom West writes:

I think it would be more accurate to say that people are typically nice and generous in specifics, but when dealing with abstracts, they want to maximise what goes to themselves.

That's probably fair. Certainly I'm more cynical about people in the abstract and am usually proven wrong in the specific.

those speculators were transferring the batteries to people who valued them more than you did

Given the circumstances, one would also have to factor in my value of helping them in their scheme at -$50 :-).

That's what the market does: transfer resources from low value to high value uses.

I always wince at phrasing like this, since it implies that if you don't have money, then fulfilling your needs has no value. Now, of course, economically that is correct, but the use of the word value has a bad habit of spilling over into casual usage in an unpleasant way.

Charley Hooper writes:

@Tom West

You are correct that those without money are left out of the equation. But we are all richer than we think. Consider how much money you could come up with in a month if you had to. And, besides, who doesn't have enough money to buy batteries?

Tracy W writes:

@Tom West:
I always wince at phrasing like this, since it implies that if you don't have money, then fulfilling your needs has no value

How would you phrase that point then? Because it's still a very important one: we are all better off, including the poor, if resources are used more efficiently (in the broad sense of efficient).

Daublin writes:

@DH: It sounds like you've found a good topic to pick apart, should you want to. I am surprised at the number of people who think there is some sort of word game or trick going on in your post.

Tom West writes:

Because it's still a very important one: we are all better off, including the poor, if resources are used more efficiently (in the broad sense of efficient).

In the long term, yes. But it's pretty hard to see how (for example) I'm better off right here and now if I starve to death while my wealthier neighbor has enough food for 10, even if efficiency is being served.

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