Why the world needs more speculators

12th July, 2008

When the economy is in turmoil, no one is demonised more than the speculator. First, we are told, speculators have driven up the price of oil, condemning us to expensive heating and motoring. Then, they have driven down the price of bank shares, dealing vicious blows to the City’s noblest banks. All of this, we are supposed to believe, is immensely profitable and highly destabilising.

With one exception – that I’ll come to – I am not persuaded. I struggle to understand how speculation is supposed to be both profitable and destabilising, all at once. Profitable speculation requires buying low and selling high. Destabilising speculation requires the opposite: short-selling shares in a trough, thus deepening the trough, and betting that frothy shares will become frothier. In other words, destabilising speculation means selling low and buying high. If that is a recipe for profit, I am missing something.

Profitable speculators, in contrast, are veritable philanthropists. When they think oil is going to become more expensive, they buy and hoard oil, or they buy oil futures, encouraging others to buy and hoard. This raises oil prices when they are relatively cheap, and lowers them later when they are relatively expensive. (The corollary, incidentally, is that if central banks lose money when “stabilising” the currency, stabilisation is precisely what they failed to achieve.)

True, when speculators make mistakes, that is destabilising. But in the case of oil prices, it’s hard to see that speculators are playing much of a role. For one thing, inventories don’t seem to be rising; if the inventory data is correct, consumers were burning all that $145 oil.

For another, speculation and prices don’t seem to be closely correlated. BP’s recent Statistical Review of World Energy points out that while few speculators have been betting on a spike in the price of heating oil, its price has soared even more rapidly than the crude-oil price. More striking, speculators have been betting that natural gas prices will slump. Natural gas prices haven’t.

If the intellectual case against speculators is weak, one can always fall back on the emotional one. Short-sellers are a particularly easy target: their hope that prices will fall hardly seems constructive. It is not much of a stretch to move from abhorrence at the idea of short-selling to the implausible conclusion that it is the short-sellers who are dragging down prices. As the great investment writer Fred Schwed Jr commented: “Only the thoughtful ask, ‘What is happening to us?’ The popular cry is, ‘Who is doing this to us?’ and its satisfying sequel – ‘Just let me get my hands on him!’”

In some rare cases, the short-seller really is the one causing the problem. For example, it might be possible to sell a retail bank’s shares short, start unfounded rumours about the bank’s liquidity and cause a run on the bank, making the rumours self-justifying, destroying a valuable asset and making money into the bargain. We should never feel comfortable about short-sellers who also (independently of their short-selling) possess the power to destroy – be they rumour-mongers, board members, or just a sportsman backing himself to lose.

This is the exception mentioned earlier. But I can’t help feeling that the “sell-short, start rumour, make a killing” strategy is more easily planned than executed.

No, the world needs more speculators, especially of the short-selling variety. There is nothing inherently wonderful about inflated prices, but it is not easy to bet that prices will fall. More short-sellers in the dotcom bubble of the late 1990s, and the housing bubbles of the past few years, would have added a welcome dose of stability and sanity. Alas, there were not enough short-sellers – and given the amount of money they were losing at the time, the only people complaining about them were their impoverished families.

Also published at ft.com, subscription free.

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