Bless the Speculator

Speculators play a crucial role in a free society, helping reduce market volatility. Yet critics like John McCain scapegoat them constantly. It's time these critics learned some basic economics.

“I believe there needs to be a thorough and complete investigation of speculators to find out whether speculation has been going on and, if so, how much it has affected the price of a barrel of oil.

“There's a lot of things out there that need a lot more transparency and, consequently, oversight.”

Those are the words of presidential candidate John McCain. This man is the Republican?

There's more.

“I am very angry, frankly, at the oil companies not only because of the obscene profits they've made but at their failure to invest in alternate energy to help us eliminate our dependence on foreign oil.

“They're making huge profits and that happens, but not to say, 'We're in this so we can over time eliminate America's dependence on foreign oil,' I think is an abrogation of their responsibilities as citizens.”

Let me get this straight. A potential president of a putatively free country scolds companies for “obscene profits,” failure to invest in competing products, and therefore irresponsible citizenship. Why? Is McCain running for national economic commissar?

This is not the first time McCain has displayed what I would call an anti-capitalist mentality. In an early presidential debate he countered former businessman Mitt Romney's claim to superior executive experience by saying, “I led the largest squadron in the U.S. Navy, not for profit but for patriotism.”

Why the put down of profit?

It's clear McCain does not understand how markets work or why they are good. He certainly doesn't understand the role of speculators and other middlemen.

He's not alone. Speculators are among the most reviled people in history. When they were members of ethnic minorities, they have been easy targets for economically illiterate people who were jealous of their success.

McCain wonders “whether speculation has been going on.” He needn't wonder. Speculation always goes on. Speculation means to take a risk on what the future holds in hopes of making a profit.

The world's stock and commodities markets are based on this principle. Sen. McCain must have meant it when he said, “I know a lot less about economics than I do about military and foreign policy issues.”

I doubt that speculators are responsible for much of the run-up of oil prices. Why didn't they run them up sooner? Besides, there are too many other explanations: increased demand from China and India, the declining dollar and Middle East tensions.

Even if speculators did play a role, what McCain apparently doesn't understand is that speculators perform a valuable service. Most people don't realize this because on the surface speculators don't seem productive. They buy what already exists and resell it. How does that help society?

In fact, the hated speculator is a good guy because his buying and selling reduce volatility and uncertainty in an unpredictable world.

He may only be out for his own profit, but that doesn't matter. As Adam Smith wrote, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest."

The prices of commodities often change unexpectedly, making business risky. The speculator brings a degree of certainty to otherwise risky ventures.

When supplies of a commodity are plentiful and prices low — but speculators expect the price to rise later — they buy — cushioning the collapse of prices.

When supplies become scarcer and prices rise, they sell — easing the shortage and lowering the price.

Also, speculators may agree to buy a commodity in the future for a price locked in today. This reduces the risk for an oil producer or farmer who fears investing because he doesn't know what price his product will sell for next year.

As a result of these activities, volatile supplies and prices are evened out over time.

Occasionally, speculators increase volatility. Markets are never perfect. (Although they are better than government regulation.) But in general, speculators increase liquidity and keep the market on a more even keel. This makes long-term planning easier for everyone.

It would be nice if McCain would finally learn some economics.

John Stossel is co-anchor of ABC News’ “20/20” and the author of Give Me a Break: How I Exposed Hucksters, Cheats, and Scam Artists and Became the Scourge of the Liberal Media (January 2005) as well as Myth, Lies, and Downright Stupidity: Get Out the Shovel — Why Everything You Know Is Wrong (May 2007), which is now available in paperback.

9 comments from readers  

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Well the world is becoming big time socialistic, when I give my point of view to people they look at me like a psycho money loving bastard that doesnâ??t care about society (which is totally wrong) I wish one day one of you guys will run for presidency.

Any ways very good post, thanks.
Dy-no-mite, John!!

A succinct explanation of Eco 101 for the economically illiterate (read "people 'educated' in America").
I agree totally with John Stossel, and probably many other market economists, about the need for and the good done by "speculators". Unfortunately the message about speculators has been hyping the debate today about what should be done about high oil, and thereby high gasoline prices. What Stossel says about John McCain could also be said about big mouthed opinion journalists like Bill O'Reilly. Stossel appeared on the Factor recently to play the fall guy for O'Reilly, but John never gave any ground. However, I didn't see that the message got through to O'Reilly. He just shuts out any good information that may confilict with his current thinking. Thanks for tryiing to get the correct message out John.
Mr. Stossel: You Americans have two sweethearts running for president this year. De Touquerville wrote that each succeeding Pres. is stupider than his predecessor. We have finally reached the bottom of the barrel. What does the next 4 years bode for America? We have a sycophant who is going to suck up to Iran, just what America needs, and what appears to be an idiot. I know nothing about McCain, but everything I am hearing is he is a mental midget. Surely there must be some Governors, or Senators who would have made powerful Presidents and put America back on its feet. Someone recently wrote that America has never done anything right on the world stage in its history, yet had the fortunate knack of always landing on its feet and smelling like a rose. Is that what our Government is counting on? Pretty shaky legs if you ask me. Glad that I am old. Who the hell would want to be young at this particular stage of our history. Keep writing, maybe somebody who can do something is reading this stuff.
I agree that speculators can "even out a market" however the current structure allows very little capital investment in order to control large quantities of commodities. An investor only needs 7.5% of the total value of the commodity in order to enter into a position when dealing with futures.

While increasing the capital requirements isn't the best solution since it will eliminate some of the smaller investors, the fact that the remaining speculators will not be able to control as much of the market individually, I believe, makes up for that loss. Another possibility would be to reduce the ratio on commodity futures to cover a smaller proportion of the commodity for each futures contract.

There is some suspicion that the "Enron loophole" has removed a significant amount of regulation from the energy futures market. While this is debatable, what is not debatable is that facts and knowledge in an open market make for a more efficient market where prices are more related to facts than to guesses and gut-feelings.

Keep in mind that the crash of 1929 was propagated by 2 major factors - short selling and futures. Both of which were subsequently regulated in ways that increase the necessary capital to enter into each of those positions. The uptick rule, and higher margin requirements quelled the short selling problems, while the decrease in the number of shares controlled by an options contracts reduced the effect of speculators.

I don't think that a government regulated market is the solution, but modifying the regulations that are currently in place would be a step in the right direction.
Marlize V
0 points
Very, very good article. It's sad that both of our presidential candidates know so little about simple, free market principles. I'm not even sure who to vote for any more -- the liberal who at least knows he's a liberal, or the conservative who doesn't know he's actually a liberal?

I've continually heard oil company executives blamed for their "shameful windfall profits" -- even being brought in front of Congress to explain themselves. What's there to explain? Demand has gone up, and American consumers are obviously OK with paying $4+ a gallon for gas... because they are. People never pay more for something than it's worth; including oil. Yet consumers themselves are never "blamed" for oil prices, only the suppliers and speculators who meet their oil-thirsty demands are.
A wonderfully good job of explaining the role of speculators. Unfortunately, taking Economics 101 and 102 at most universities will not provide such basic economics knowledge. In fact, I had to explain the role of speculators to a graduate student in economics at Brown University who was teaching Econ 102 back in 1966. I had tested out of Econ 101 and was taking the second half of the course to fulfill a distribution requirement as a physics major. The role of speculators was not covered well in the Samuelson textbook of that day, but it takes little observation power to figure out what it is and why it is needed. People had provided the service for a few thousand years, so clearly some people had figured this out. Strange that so many "well-educated" elites and politicians cannot figure it out!
very well written mc cain is maybe a former hero but is downright stupid about economy
John Stossel is a very bright light in an increasingly dark world of stupidity and ignorance. As a society we have very few people who have the courage to think, much less think for themselves. And as always with at least a particle of rationality. Go John GO!
To post comments, please log in first. The Atlasphere is a social networking site for admirers of Ayn Rand's novels, most notably The Fountainhead and Atlas Shrugged. In addition to our online magazine, we offer a member directory and a dating service. If you share our enjoyment of Ayn Rand's novels, please sign up or log in to post comments.