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Tuesday, March 20, 2012

14. Speculators

The Concise Guide To Economics

by Jim Cox

14. Speculators

Speculators--those attempting to gain by guessing future conditions (in particular prices)--are a subcategory of entrepreneurs; everything written previously about entrepreneurs applies as well to speculators.  However, while the public will often have sympathy and understanding for the role of entrepreneurs, there is a general disdain for speculators. 
In redeeming the reputation of speculators let me first point out that everyone speculates.  Consumers speculate when they decide to buy a house now rather than wait for lowering prices or mortgage rates, students speculate when they choose a major in college, etc.  But beyond noting the universal practice of speculating there are other redeeming qualities to speculators. 
If, for instance, someone is speculating in the future price of sugar then he will pay much more attention to the weather conditions, technology, and political influences on sugar than will the consumer.  For the consumer, sugar is a passing and minor part of his life; for the speculator it is his means of livelihood.  At a time when the price of sugar is $1 per pound a speculator will begin buying sugar if he has reason to anticipate a future lack of supply.  His speculative demand added to that of consumer demand will increase the price to say, $1.50 per pound. This is one source of the animosity typically directed by the public toward speculators. 
The higher price will have two effects:  First, the consumer will begin to economize on sugar, treating it as more valuable than before.  And second, suppliers will be encouraged to produce more sugar than before.  The speculator is, in effect, acting as an early warning signal notifying others of the impending future reduction in supply--much like a smoke detector alerts otherwise distracted residents about a spreading fire.  Then when the reduced supply becomes evident to all, the speculator will dump the sugar at the now even higher price of say, $2.00 reaping a $0.50 profit per pound.  This is another source of the animosity typically directed by the public toward speculators. 
But, what has the speculator actually done?  He has taken the plentiful sugar away from consumers when they were ignorant of its future higher value and returned it to them just when they needed additional supply the most--he has provided a marvelous service to others in the pursuit of his personal gain.  He should be cheered for his actions; he is a benefactor of consumers.
Another way in which speculators do good but receive condemnation is in futures contracts.  Take the example wherein a farmer has planted his peanut crop in January when the price of peanuts is $2 per pound.  The farmer will not reap his harvest until June, by which time the price of peanuts may have changed dramatically.  A speculator comes along and offers the farmer $2.20 for every pound he can deliver in June. 
If the farmer accepts the deal then he can concentrate on his farming without worrying about some uncertain future price for his peanuts.  He can sleep peacefully at night, certain of his price because the speculator has agreed to shoulder the burden of future price changes.  A division of labor has occurred with the farmer specializing in farming and the speculator in risk-bearing.  If the price of peanuts in June falls to $1.50 then the farmer will be overjoyed that the speculator has saved him from such a catastrophe and will think speculators are the best people on earth.
But if the price in June goes to $3.00 per pound the farmer will curse the name of the fast-talking slicky salesperson of a speculator who deprived him of the high profits.  The farmer will forget all about the peaceful sleep he enjoyed due to the speculator's guaranteed price, and he'll forget all about the fact that he freely chose to enter into the agreement in the first place.  This is yet another reason for the public's negative view of speculators. 
But, which speculator will be around to speculate again?  The one so popular with the farmer has lost a fortune and cannot or will not care to try his hand again.  The successful speculator, the one the farmer has such disdain for, has made a major profit and will be able and interested in pursuing another contract.  It at least makes some sense that speculators are unpopular, but in evaluating their role in the economic system they should properly be regarded with the same appreciation as all other productive parties.

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