Speculators, by profiting, provide a service

Speculators are selfish people, acting only to make as much profit as possible for themselves without concern for the welfare of others. By doing so, they provide a valuable public service.

That’s not what we hear when oil and gasoline prices — to take a recent example — go up. News commentators from across the political spectrum condemn speculators, blaming them for rising gasoline prices.

The mechanism of the speculator is to buy something like oil when prices are low, then to sell it when prices are high. By doing so he earns a profit. (An alternative is to sell things he does not yet own when prices are high, and then buy to fulfill his obligation when prices are low.)

The speculator, in this definition, does not hope to profit by processing and distributing the commodity he is buying and selling, as does an oil company or flour miller. He simply hopes to make a profit based on the changing prices — up or down — of oil or wheat.

It is said that speculators are buying oil now and therefore driving up the price. That’s probably true, and it illustrates one of the beneficial services that speculators provide: they reduce volatility in prices. If speculators are correct and the price of oil spikes sometime soon, the present buying by speculators makes the spike less steep. It also induces consumers to conserve.

Writing about speculation in food markets, Walter Block explains the beneficial effects:

First, the speculator lessens the effects of famine by storing food in times of plenty, through a motive of personal profit. He buys and stores food against the day when it might be scarce, enabling him to sell at a higher price. The consequences of his activity are far-reaching. They act as a signal to other people in the society, who are encouraged by the speculator’s activity to do likewise. Consumers are encouraged to eat less and save more, importers to import more, farmers to improve their crop yields, builders to erect more storage facilities, and merchants to store more food. Thus, fulfilling the doctrine of the “invisible hand,” the speculator, by his profit-seeking activity, causes more food to be stored during years of plenty than otherwise would have been the case, thereby lessening the effects of the lean years to come.

If the spike in prices does occur, what will speculators do? They will sell their oil, and that action will drive down prices, making the spike less steep. Here the speculator makes a profit by providing the service of making the oil shortage less severe. His hoarding of oil, bought when prices were low, makes it available in times of need, and less expensive, too. The speculator is rarely given credit for that in public, although this is how the speculator earns a profit.

It is possible for speculators to do harm, however. If the speculator buys, he drives up prices. Then suppose the price of oil falls, and the speculator is forced to sell. His actions have increased the volatility of oil prices and have sent false price signals to the market. Citing again Block’s food example: “What if he is wrong? What if he predicts years of plenty — and by selling, encourages others to do likewise — and lean years follow? In this case, wouldn’t he be responsible for increasing the severity of the famine? Yes. If the speculator is wrong, he would be responsible for a great deal of harm.”

In these cases, the speculator has suffered financial losses. These loses are a powerful market force that drives “bad” speculators — meaning those who guess wrong about future prices — out of the market.

The real danger is when government attempts to speculate. That’s a possibility at the current moment, as many are recommending that the U.S. government sell oil from the strategic petroleum reserve in an effort to lower the cost of oil. That’s speculation — the oil was bought at a time when the price was lower, and is now contemplated being sold at a higher price.

The problem with government speculation is that government does not face the market discipline that private-sector speculators face. When they are wrong, they lose their capital. They go out of business. Government faces no such discipline. When government is wrong, it goes on.

Government attempts at regulating speculators are certain to fail, too. Almost any such regulation will seek to reduce the profit potential of speculation. But that is what drives the speculators and makes the system work. Without the potential for profits, speculators will not take the risk of losses, and they will not perform their beneficial function.

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