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Andrew Lilico

Andrew Lilico: In praise of speculators

In a widely-reported section of his Christmas sermon, the Archbishop of Canterbury stated the following:

The most pressing question we now face, we might well say, is who and where we are as a society. Bonds have been broken, trust abused and lost. Whether it is an urban rioter mindlessly burning down a small shop that serves his community, or a speculator turning his back on the question of who bears the ultimate cost for his acquisitive adventures in the virtual reality of today's financial world, the picture is of atoms spinning apart in the dark.

I shall leave analysis of Rowan's full remarks to another time. But here, in likening a speculator to a rioting arsonist, Dr Williams very much reflects the zeitgeist. Financial speculation is seen as, at best, a necessary evil we benefit from by taxing, or perhaps must tolerate if we are not to chase more productive acitivites away. Others - including perfectly respectable international figures such as the President of France, regard financial speculation as the cause of unemployment, low salary growth, business failure and recession for millions.

I beg to differ. Financial speculation is overwhelmingly a good thing, and those that are involved in it add value to society. Even if we could ban financial speculation without banning anything else or without losing any tax revenue as a result, we would be much worse off if we did so.

How so? First, understand how speculators make money. They do so by acquiring better understanding or information than is the average in the marketplace. Of course, a tiny minority do so illegally, through insider dealing - but that's irrelevant; there are criminals in every profession. The vast majority gain their superior understanding or information through gathering and analysing data better than is done by others. Because they have better understanding or information, they can identify opportunities for trading - situations where assets are over- or under-valued compared with a proper understanding of their prospects.

Speculators then use their knowledge to make money. They buy under-valued assets and sell over-valued assets. When they do so, particularly when others discover that they have done so, prices shift. Under-valued assets rise in price; over-valued assets fall.

Why is this of social value? A number of reasons. At the most basic level we have the rather nerdy point that when the prices of assets better reflect their true underlying fundamental value, markets are functioning more efficienctly, so investment becomes allocated more efficiently and the assets in the economy will tend to produce more for a given amount of those assets. This point is simpler than it probably sounds to most readers, but it's also rather dull. However, it shouldn't be ignored as we go on to explore some of the more interesting benefits of speculation.

The next point to note is that because one can make money from speculating off the back of increased understanding and information, people have incentives to acquire better understanding and information. In the absence of speculators, we'd just be less well informed about the prospects of firms, governments, and so on. Being well-informed is of value to other investors, as well as the speculators - if speculators have helped to identify that some company is at risk of going bust, it is less likely that some old lady will put her life savings into it just as it's about to go bust.

Next, speculation is of value to the firms themselves. Firms tend not to complain much about positive speculation - when speculators believe they have identified that a firm's prospects are much better than most people had thought, and buy shares heavily, one rarely sees Chief Executives on the television condemning the evils of speculation. Firms tend to take a different view when speculators consider a firm's prospects less rosy than the firm itself claims they are. Similarly, governments often claim that negative speculators are just plain wrong to be selling their bonds. But when a firm or a government is at risk of going bust, that is very often because the current management / government is not in full command of the situation (indeed, more often that than for the management / government to be lying) - the speculators often understand the prospects of a firm or government better than the management / government itself. One consequence is that, because speculators can only make their money if they trade before matters have become obvious, speculation will often occur at a point at which it is still, just, possible for the firm or government to turn things around, if it acts quickly and decisively. (Of course, sometimes, because speculation must occur early, and, strange as it may seem, because it is inherently "speculative", it will be mistaken.) The speculation itself can provide a window of opportunity for a firm or government not to go bust, when without the speculation occuring, default would have been inevitable.

I could go on, but the idea should now be clear. Speculators provide an enormous service, by increasing information and understanding. They enhance broader economic efficiency. They inform other investors. They reduce the risk of the naive being burnt. And when speculation identifies weaknesses, it creates opportunities for turn-around.

Obviously some speculators are crooks - but so are some lawyers; should we ban people from being solicitors? Some speculators get things wrong - but so do some inventors; should we ban invention? Some speculators are cynical about the capacity of firms or governments to change - but so are many newspapers; should we then ban journalism?

Here's my bit of cynicism: I suggest that speculators are hated because people don't understand what they do, because they are rich and secretive, and so they make an easy target. I don't believe it's any more complicated than that.


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