Question About Speculation

[uberliber]

Hey, I have a question about speculation.

I don't really understand something that Rothbard and Mises say a lot. I don't have the books here, but I can kind of remember their basic premise.

They say that speculation is not harmful. All it does is speed up the process at which the prices reach the equilibrium.

Can anyone explain this to me?

Thanks!

[joel]

Hey, I have a question about speculation.

I don't really understand something that Rothbard and Mises say a lot. I don't have the books here, but I can kind of remember their basic premise.

They say that speculation is not harmful. All it does is speed up the process at which the prices reach the equilibrium.

Can anyone explain this to me?

Thanks!

Rothbard has a good explanation in chapter 2 of Man, Economy, and State. He explains that speculation does not change the equilibrium point but makes the supply and demand schedules more elastic. Because they are more elastic, smaller changes in price result in larger changes of quantity, and thus larger surplusses and shortages of the good, which will hasten the adjustment. (http://mises.org/rothbard/mes/chap2c.asp)

In another thread (http://www.theologyweb.com/campus/sh...postcount=1019) I gave some time-sequence examples, and explained that speculation tends to produce changes of lesser magnitude than without speculation. The presence of speculation makes the expected future changes less extreme, and thus speculation is self-correcting.

Let me know if you have any further questions.

[uberliber]

Ah, that makes sense. Thanks a lot. I also just found a chapter on speculation in Theory of Money and Credit.

[flaja]

Hey, I have a question about speculation.

I don't really understand something that Rothbard and Mises say a lot. I don't have the books here, but I can kind of remember their basic premise.

They say that speculation is not harmful. All it does is speed up the process at which the prices reach the equilibrium.

Can anyone explain this to me?

Thanks!

Both Rothbard and Mises are fruitcakes. Speculation does nothing but create false demand for something which means prices are raised higher than the real market value would otherwise allow. Speculation is precisely why we have the current mortgage crisis. There was so much speculative demand for real estate that properties were mortgaged for more than they were really worth. And we often see the same thing in the energy and commodity markets.

[joel]

Both Rothbard and Mises are fruitcakes. Speculation does nothing but create false demand for something which means prices are raised higher than the real market value would otherwise allow.

You'll have to justify these assertions.

Some comments in the meantime:
- First of all, it is undeniable that correct speculation does not change the equilibrium point, but merely makes supply and demand more elastic. Speculation may increase the height of the demand schedule at prices below the equilibrium, but will decrease the height of the demand schedule at prices above the expected equilibrium.
- There is nothing about speculation that inherently raises prices. When prices are believed to be above equilibrium, speculation will work to hasten prices falling to equilibirum.
- Thirdly, erroneous speculation is self-correcting, not self-perpetuating.
- Fourthly, in the above-mentioned passages, Rothbard and Mises were discussing speculation in an unhampered market. Elsewhere they discuss the case of interventionism like we have: such as expansion of the money supply and credit, manipulating interest rates below equilibrium, and otherwise subsidizing credit risk. That is clearly why there was excess investment in the real estate (and other) markets, not some nebulous "speculation" that came out of nowhere.

[Augustine2004]

You'll have to justify these assertions.

Some comments in the meantime:
- First of all, it is undeniable that correct speculation does not change the equilibrium point, but merely makes supply and demand more elastic. Speculation may increase the height of the demand schedule at prices below the equilibrium, but will decrease the height of the demand schedule at prices above the expected equilibrium.
- There is nothing about speculation that inherently raises prices. When prices are believed to be above equilibrium, speculation will work to hasten prices falling to equilibirum.
- Thirdly, erroneous speculation is self-correcting, not self-perpetuating.
- Fourthly, in the above-mentioned passages, Rothbard and Mises were discussing speculation in an unhampered market. Elsewhere they discuss the case of interventionism like we have: such as expansion of the money supply and credit, manipulating interest rates below equilibrium, and otherwise subsidizing credit risk. That is clearly why there was excess investment in the real estate (and other) markets, not some nebulous "speculation" that came out of nowhere.

Rothbard said that all actions are necessarily speculations. Your reading this post is speculative; there might be something else you will wish later you were doing instead.

Speculations as above does not necessarily involve trading.

However, clearly speculation in this thread means risky action intended to improve one’s future financial position by a considerable percentage. I don’t care to try to distinguish between ‘speculation’ and ‘investment,’ however.

Flaja clearly needs to study what the Federal Reserve System and other ‘central-bank’ cartels have done to the world economy and are doing. One point he should grasp is that in today’s environment, investment is impossible. We all have to speculate. We won’t have slowly-changing prices. Severe inflation or quick deflation? Likely to happen. My bet’s on severe inflation. Hyperflation is possible.

Inflation of the money supply does create ‘false’ demand by distorting the price structure of the economy, especially interest rates. People are induced to speculate on rising prices. Uniformity of price rises over time is impossible, so several hot spots develop. Possibly cold spots, also, but overall prices rise. The future is still unpredictable, but people tend to continue what had worked in the past, especially build up their businesses when demand appears to increase.

[joel]

Rothbard said that all actions are necessarily speculations. Your reading this post is speculative; there might be something else you will wish later you were doing instead.

Speculations as above does not necessarily involve trading.

However, clearly speculation in this thread means risky action intended to improve one’s future financial position by a considerable percentage. I don’t care to try to distinguish between ‘speculation’ and ‘investment,’ however.

That is a good point, that all action is speculation. It simply refers to action being anticipatory. In Chapter 2 of Man Economy and State (linked to above), and in this thread, the specific sub-category is anticipation of future prices. In this limited context, Rothbard distinguishes between two reasons to hold on to a good (including money): the direct-use of a good and the holding onto it to sell it in the future. A person will choose what is higher on their value scale. But, yes, in the broader sense, even the decision to engage in direct-use of the good is a decision to use it in the future, to have satisfaction in the future, and thus is speculative.


It occurs to me that my referring to a demand schedule being "higher" in my previous post may be confusing. I was thinking higher on the vertical axis, which is usually price. For the purpose of clarity, I should probably have referred to quantity. Thus, at a price below the anticipated equilibrium, the demand schedule will be larger in quantity (for people will want to buy now before prices rise), and at a price above the anticipated equilibrium, the demand schedule will be smaller in quantity (that is, people will delay their purchases until prices fall).

[flaja]

You'll have to justify these assertions.

The dotcom bubble followed by the mortgage bubble is justification enough. A bubble works only as long as everyone thinks it will continue to expand and thus buys with the expectation that the price will go up in the future. But when people begin selling to make their profit with the inflated price the supply is no longer smaller than the demand and prices fall to the point that the bubble bursts.

- First of all, it is undeniable that correct speculation does not change the equilibrium point, but merely makes supply and demand more elastic.

Speculation always means you are buying something that you do not need and will not consume because you want to sell it in the future at a higher price so you can make a profit. Speculation is always false demand that manipulates market prices.

You really think all of the greedy • Edited by a Moderator • at the Chicago Board of Trade really need all of the oil that they buy everyday? Get real.

Moderated By: rogue06

While the sentiment is understandable, the language was inappropriate

***If you wish to take issue with this notice DO NOT do so in this thread.***
Contact the forum moderator or an administrator in Private Message or email instead. If you feel you must publically complain or whine, please take it to the Psychotherapy Room unless told otherwise.

[flaja]

Flaja clearly needs to study what the Federal Reserve System and other ‘central-bank’ cartels have done to the world economy and are doing.

Take your insulting tone • Edited by a Moderator •

Moderated By: Michelle

As in the post above, your word choice was disruptive.

***If you wish to take issue with this notice DO NOT do so in this thread.***
Contact the forum moderator or an administrator in Private Message or email instead. If you feel you must publically complain or whine, please take it to the Psychotherapy Room unless told otherwise.

[joel]

The dotcom bubble followed by the mortgage bubble is justification enough.

How is it justification for any of those assertions?

A bubble works only as long as everyone thinks it will continue to expand and thus buys with the expectation that the price will go up in the future.

One of the things that a theory of bubbles or depression has to explain is why was there a cluster of errors? We expect that businessmen and investors will make individual mistakes now and then, but why do they not cancel out due to the law of averages, as well as the fact that such an error creates opportunity for profit in the other direction? Thus the explanation for the bubble/depression has to explain why there would be a cluster of errors. Why would everyone (or nearly everyone) in the economy make the same mistake in the same direction?

One attempted explanation I believe is the one you are trying to make--that somehow there is a herd or copycat behavior causing everyone to move in the same wrong direction. But this fails on a few different levels.

First is that it does not explain why this does not always happen. Why does not everything inflate into bubbles all the time? Why does only some speculation lead to bubbles while other does not? You would need to elaborate your theory to explain this.

Secondly is that if (scarce) resources are erroneously diverted to a bubble industry (say dotcom or housing), they are diverted from somewhere else. This underinvestment in other industries would reveal itself as an opportunity for profit for anyone who moved resources back the other direction. Thus your theory would have to explain how this profit signal was destroyed or distorted so that the bubble could continue to exist and inflate.

As you point out, the theory would have to explain what would sustain mistaken anticipation of great profits?

Mises' theory explains these things.

Speculation always means you are buying something that you do not need and will not consume because you want to sell it in the future at a higher price so you can make a profit.

I'm not interested in a debate over the definition of a term. But why are you restricting discussion to only purchase with the intent to sell later at a higher price? Not much different is the person who already has a good, and continues to hold it with the intention of selling later at a higher price. Both are increases in the demand to hold. And why not also consider someone who anticipates a lower price and sells sooner than otherwise, or someone who delays a purchase waiting for lower prices? Likewise an owner anticipating lower future prices may sell their good now with the intention of purchasing it back after the price drops.

Speculation is always false demand that manipulates market prices.

It is not always false demand. I have shown that to be false. Correct speculation clearly is not false demand and does not affect the equilibrium price, but only makes the demand and supply schedules more elastic.

Not only that, but buying now to sell later at a higher price tends to cause future prices to be lower than they would be otherwise, as I explained in the post I linked to in Post #2 above. For example, if you expect a future famine (or oil wells to slow) you may expect prices to be higher upon that future occasion. Thus you may buy food (or oil) now with the intention of selling it at that higher future price. This profit motive provides a beneficial social function. It results in people storing up food (or oil) for the future time of lack. It results in prices rising sooner, before the disaster hits, thus providing incentive for increased production (and production capacity) of that good. The result will be that the future famine will not be as severe, and prices will be not as high because of the speculators. Thus the "false demand" you describe is quite likely to "manipulate" prices to rise less high than they would have been otherwise.
(This is another reason why speculation is self-correcting. The existence of this kind of speculation, for instance, lowers present expectations of the future price. It does not perpetuate it, as you suggest.)

If the price of a good varies from location to location, people can take advantage of that opportunity for an arbitrage profit. This is socially beneficial. It coordinates supply and demand across space, and facilitates the division of labor and economical use of resources, making everyone better off. Likewise speculation coordinates supply and demand across time, with similar economical benefits.

[Augustine2004]

Governments’ buying things may indeed be ‘false demand.’ However, in re the free market, that term seems too facile and pejorative. To be sure, one may make a purchase that he later regrets making. However you were talking about speculation in the sense of buying or holding things in the hope of making profits later in a somewhat free market. Unfortunately, Flaja resented my expressed opinion that he needed to study the effects of fractional-reserve banking with unlimited fiat money, so I’m wondering what next to say.

[joel]

We may also point out that buying a good G and holding it with the intention of selling it at an anticipated higher price in the future is not substantially different from purchasing the factors of production that result in the production of G with the intention of selling G in the future, such that the future (discounted) price of the product G is anticipated to be greater than the cost of the factors of production. In both cases, your act is to purchase a good G such that you intend to sell it at a higher price in the future. Therefore, all entrepreneurial activity is speculation of the kind flaja refers to.

[Augustine2004]

I just read this: ‘Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage.’
http://www.telegraph.co.uk/finance/c...one-of-us.html
I confess I didn’t think of that. Of course speculators will take advantage of cheap and easy credit. I mean, that’s something to expect. But I didn’t think about arbitrage in the futures market. I’m not sure how bad that effect is; my guess it’s bad for prices to change so rapidly if people are saving much.