Thursday, May 17, 2012

In Praise of the Speculators, Who Smooth Out Production and Consumption, and Benefit Society

From the article "Why Speculators?" by Percy L. Greaves, which originally appeared in the November 1964 issue of The Freeman:

"Frequently, the speculator is the first to foresee a future scarcity. When he does, he buys while prices are still low. His buying bids up prices, and consumption is thus more quickly adjusted to future conditions than if no one had foreseen the approaching scarcity. A larger quantity is then stored for future use and serves to reduce the hardships when the shortage becomes evident to all.

Since a price rise tends to encourage increased production, the sooner prices rise, the sooner new and additional production will be started and become available. So a successful speculator reduces both the time and the intensity of shortages as well as the hardships which always accompany shortages.

Likewise, speculators are often the first to foresee an increase in future supplies. When they do, they hasten to sell contracts for future delivery. This in turn drives down future prices earlier than would otherwise be the case. This tends to discourage new production that could only be sold at a loss. It also gives manufacturers a better idea of what future prices will actually be. So, here again the speculator tends to smooth out production and consumption to the benefit of all concerned.

A good example of how speculators serve society was provided in the coffee market a few years ago. A small newspaper item reported a sudden unexpected frost blight in Brazil. Speculators immediately realized that such a frost must have killed large numbers of coffee bushes. This meant much smaller future supplies for the United States. So the speculators promptly bought all the coffee they could below the price they thought would prevail when consumers became fully aware of the approaching shortage. This tended to raise coffee prices immediately.

The effect of this was to reduce consumption and stretch some of the existing supply into the shortage period. It likewise alerted coffee growers in other areas to be more careful in their picking and handling of coffee so that there was less waste. Higher prices encouraged them to get to market every last bean, which at lower prices would not have been worth the trouble. Higher prices also speeded up the planting of new bushes. Since it takes five years for a new coffee bush to bear berries, the sooner new planting was undertaken the shorter the period of shortage.

The speculators who first acted on this development served every coffee consumer. If these speculators had not driven up prices immediately, consumers would have continued drinking coffee at cheap prices for a time. Then, suddenly, they would have faced a still-greater shortage and still-higher prices than those that actually prevailed.

By buying when coffee supplies were still relatively plentiful and selling later when the shortage was known to all, speculators helped to level out the available supply and reduce the extreme height to which prices would otherwise have risen. Speculators make money only when they serve society by better distributing a limited supply over a period of time in such a manner that it gives greater satisfaction to consumers. They thus permit other businessmen and consumers to proceed with greater safety and less speculation in their own actions."
 
MP: In the example above, you could easily substitute "oil" for "coffee" and have a pretty good understanding of oil markets and oil prices over the last few months, and perhaps gain an appreciation of the role of oil speculators in helping to determine spot and futures prices for oil and gasoline, in response to changing market forces globally. And you could also understand how the media in the 1960s might have charged/blamed/accused coffee speculators for "high coffee prices," even though they were betting on market forces (falling future supply), not against market forces.  

14 Comments:

At 5/17/2012 3:09 PM, Blogger efimpp said...

it would be nice to see a math model behind these words

after all, some money are left if hands of speculators (who [suppose] will just spend them on shiny cars), rather then producers (who [suppose] will invest them in production)

 
At 5/17/2012 3:35 PM, Blogger juandos said...

"after all, some money are left if hands of speculators..."...

True but if memory serves (I linked this commentary in a comment the first time Obama started whining about the speculators a couple of years back) it seemed like at the time the numbers of speculators and their individual takes were relatively so small that it didn't amount to even a rounding error...

 
At 5/17/2012 4:06 PM, Blogger Ron H. said...

efimpp: "
after all, some money are left if hands of speculators (who [suppose] will just spend them on shiny cars), rather then producers (who [suppose] will invest them in production)
"

Wait! Do you think speculators should provide this valuable service free of charge?

Then, I always thought shiny cars were made by producers? Is that no longer true? Won't those producers of shiny cars invest in production due to the high demand from speculators?

Is there some scale of values you and I can impose on those who spend their own money on what they choose to spend it on?

 
At 5/17/2012 4:15 PM, Blogger efimpp said...

"Wait! Do you think speculators should provide this valuable service free of charge?"

so far I don't see that service is valuable.
for all I know from words net spending for consumers can be less or more, or the same.
yes, severe shortages will be eased - but to what extent it remains to be seen.

 
At 5/17/2012 7:49 PM, Blogger bart said...

I am one of those eeeeeeeevil speculators and totally agree... except about position limits.

The huge multi national bank trading desks and hedge funds *can*, due to their ability to take unlimited size positions, push prices much further (in either direction) than if there were limited.
My point is more about a level playing field than heavy regulation.

 
At 5/17/2012 7:50 PM, Blogger bart said...

The Drivers of Oil Prices:
The Usefulness and Limitations of Non-
Structural model, the Demand–Supply
Framework and Informal Approaches


http://www.nowandfutures.com/d2/speculators_make_little_price_differenceWPM32.pdf

 
At 5/17/2012 7:52 PM, Blogger bart said...

Amusing chart about speculators:

http://www.nowandfutures.com/d2/oil_prices_vs_speculators.jpg




When All Else Fails Blame the Speculators

http://www.nowandfutures.com/d2/HistoryOfBlamingSpeculators.txt

 
At 5/17/2012 8:40 PM, Blogger Methinks said...

Bart, what hogwash. Since banks don't have unlimited capital, they can't take unlimited positions in anything.

Also, if they drive prices above fair, the rest of the market will take the other side and clobber them.

Leveling a playing field by insisting that no-one can trade larger size than you is incredible bullshit.

 
At 5/17/2012 8:44 PM, Blogger Ken said...

efimpp,

it would be nice to see a math model behind these words.

It's called the supply and demand curve.

so far I don't see that service is valuable.

So you didn't read the post? Speculators drive up prices slowly rather than have prices spike suddenly. This serves two purposes: 1) It let's consumers know to conserve and 2) It let's producers know that more expensive production processes can be used profitably, increasing supply. Additionally, they smooth out falling prices as well similarly allowing consumers and producers to adjust gradually, rather than face price shocks.

In other words, they speed up the transmission of information through markets. This is incredibly valuable.

 
At 5/17/2012 8:44 PM, Blogger Methinks said...

so far I don't see that service is valuable.

Well, if YOU don't see it, then I guess we'd better whack the speculators then, eh? I mean why bother your pretty little head trying to understand speculators or that you are likely one yourself?

If you own property, stocks, bonds or any other assets, you're a speculator.

Speculators in the financial markets add liquidity and reduce volatility and transactions costs. And sometimes (if they're dumb or unlucky) they do it at their expense. So, if you don't consider the ability to enter and exit your positions at a lower cost without moving the price against you, then I guess the service is not valuable to you, but it is to everyone else. Although, I have to wonder why you'd rather pay more to transact and move the price against yourself as you do.

 
At 5/17/2012 10:10 PM, Blogger Ron H. said...

efimpp: "so far I don't see that service is valuable."

You don't see early warning of future price changes as being valuable? Interesting.

"for all I know from words net spending for consumers can be less or more, or the same.
yes, severe shortages will be eased - but to what extent it remains to be seen.
"

What does that mean?

 
At 5/18/2012 7:51 AM, Blogger bart said...

Bart, what hogwash. Since banks don't have unlimited capital, they can't take unlimited positions in anything.

They don't need anything like unlimited capital to command 1/3 or more of the total open interest in the futures market.

Do you even trade futures or have the vaguest clue of actual facts, like those from the bank participation stats etc?


Also, if they drive prices above fair, the rest of the market will take the other side and clobber them.

You apparently live in a different reality, and are unaware of the realities of trading and moving markets.

Leveling a playing field by insisting that no-one can trade larger size than you is incredible bullshit.

Nice job of completely failing, and twisting my words into 100% lies and propaganda.

What I'm talking about is, in general, big trading desks being able to easily move markets by controlling more than 1/4 or 1/3 of the total open interest. But if it's ok with you to have GS and JPM and whomever be able to control the playing field, then there's nothing else I can say.

Even Bart Chilton of the CFTC sees the problem and has been trying to get limits added so that truly egregious position sizes are not possible.

 
At 5/18/2012 11:11 AM, Blogger Methinks said...

You apparently live in a different reality, and are unaware of the realities of trading and moving markets.

No, my darling. Unlike you (a guy with a computer on his kitchen table who dabbles), I'm an actual professional trader who has been doing it every day for a very long time.

You retail twits are always bitching and moaning that you can't compete against people that have more capital, more experience, better technology, etc. than you.

Yes, I do realize that the CFTC says a lot of political stuff to soothe you. If you believe any of that bullshit you clearly haven't ever dealt with any of the regulators as a dealer.

 
At 5/18/2012 11:51 AM, Blogger bart said...

Oh my methinks, you sure do live in a different reality.

You pretend you're a trader, but have quoted zero/nada/nothing about the actual high percentages of total OI of the big trading desks, and can't/won't even comment on things like bank participation rates or all the other incontrovertible evidence of a severely un-level playing field and severe "ethical issues" of trading desks and greed freaks.


And again you show your weakness and uncertainty on the real facts via personal attacks, propaganda, lies, etc.

So you're a dealer - so what. All that means is that you have a vested interest in not seeing the crud - as proven by the attacks and belittling of very successful traders with over a decade of experience and a track record that would make most very jealous.


I'm done - you've proven you have little interest in facts or real debate.

 

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