Monday, 23 October 2017

On Speculation

One of the most overused words with awful connotations is the notion of Speculation. It produces images of reckless bankers ruining the livelihoods of common people, sending economies into deep recessions while satisfying nothing but the evil speculator's greed and occasionally enhances their wealth. Add some random slur about how George Soros broke the Bank of England and something about hedge funds, and the stereotype is complete: speculation is evil and should be banished. 
Of course, the sarcasm above is warranted only because these mistaken convictions are ridiculously deep among the general public, and sometimes even among established economists. I remember a Rethinking Economics event a couple of years ago a women outlining her view for an optimal banking system: "Raise money from depositors, make loans for the local community. No speculation - absolutely no speculation."

Now, stepping back for a moment and asking what speculation means quickly illustrate her mistake (another solution would be to read Mises, but most people are too busy bashing financial markets to do that). By any common definition of speculation what she's proposing is a contradiction in terms: extending loans, regardless of safely is by its very nature speculative. I don't even have to invoke the broader Misesian concept where speculation means acting in an uncertain future, i.e. every action, to get that result. 

If we think about it, Mises is clearly right: none of us knows the future, and so every action we take (investment, consumption, eating food, crossing the street) has a chance of failure that we subjectively evaluation before we take that action. In a sense, we're speculating on the future whenever we act in certain ways. Nothing is more true in the world of business and consumption as it is in the financial markets we normally associate with the term. But even our decisions to hold money rather than consume it is speculation (Keynes would agree, by the way), as Phillip Bagus explains in his brilliant In Defense of Deflation:
every business person and consumer is a money speculator when it comes to deciding the amount of cash balance they want to hold. One cannot avoid being a money speculator. (p. 60, emphasis added)
If one expects goods or asset prices to fall, hoarding money is a speculation in the "future rise in the purchasing power of money" (p. 60). For someone like me, with serious currency mismatch between my assets/incomes and my costs, it becomes even clearer: if I transfer money to my British bank account today rather than tomorrow, I am speculating that the exchange will be more expensive tomorrow. Similarly, not exchanging all my foreign assets into GBP today means that I foresee (=speculate) a fall in the exchange rate within the foreseeable future. There is simply no action that I can take that does not involve speculation. You can apply this thinking involving tomatoes as the supermarket or freebies in the cafeteria or friends and relationships.

Speculation properly described simply means guessing and acting in an unknowable future. It seems to me that the malign connotation 'Speculation' often carries simply means "(financial) investment of a kind the speaker does not approve of". Compare the following sentences for illustration:
- The railway speculation was large and expected to continue for many years ahead.
- The railway investment was large and expected to continue for many years ahead.

Please try telling me the difference is substance between those sentences! I've come across both of them in my readings of 19th century Britain or U.S. and it so clearly reveals the author's motives and foreshadows his(her) opinion of the railway manias. Nevertheless, it does indicate how the term speculation is misused and misunderstood. It is simply one of these words that laymen use in incorrect ways and where a better understanding of economics would make them less silly. 

Because bashing 'speculation' is beyond silly. 

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