Mar

15

Pages 178 and following of The Economic Way of Thinking: a brief summary.

(1) Speculation arises because of uncertainty about the future and is quite common. Many everyday activities involve an element of speculation. For example a college student getting an education is speculating (he hopes, but cannot be sure, that the increased income he will get after graduating will outweigh the cost and effort of going to college). Another example might be a motorist who passes by a gas station hoping to find another station with a cheaper gas price further down the road, even though the next one might actually be more expensive.

(2) A more important example involves price speculation on agricultural commodities such as corn.

If it is expected that the next corn crop will be smaller than usual (perhaps because of signs of corn-leaf blight in the Midwest corn fields) a number of economic responses take place that tend to reduce current consumption of corn and increase the amount stored for future consumption. Some of these are the result of the actions of ranchers, or companies who use or store corn in their operations; others are the result of organized futures markets. All these can be classified as speculation. The result is an increase in the spot price of corn. Heyne emphasizes that this is a beneficial effect; the price increase is a signal that corn is scarce and it encourages people to consume less corn or store more of it for the future.

As Heyne says:

"the speculative activities cause corn to be transported over time from a period of relative abundance to one of relative scarcity".


The price increase takes place even before the next corn crop comes on the market, and this is as it should be (even though some people do not appreciate it): if corn is going to be scarce we might as well start economizing on its use right away. It is entirely possible of course that the predicted corn blight will not occur, but the speculators are rewarded for being right, they lose out if they are wrong.

Participants in the futures markets include both hedgers and speculators:

"Futures markets allow people to allocate their risks and deal with uncertainty as they see fit. Those who wish to reduce their risk have the option to hedge, those who wish to increase their exposure to risk have the option to speculate."

(3) The futures markets generate information (namely accurate prices for commodities) and are thus valuable even to people who do not participate in them. For example farmers can use futures prices for corn to make crop decisions. The futures markets also encourage the generation of information, in the sense that the speculators are rewarded if they understand all factors (fundamental and technical) that affect prices and are presumably hard at work to uncover them.

(4) A favorite passage of Vic's appears on page 179:

"Adam Smith once compared those who speculate on the future price of grain to the prudent captain of a sailing ship, who puts the crew on short rations the moment he discovers there is not enough food on board to last through the voyage. Grain speculators, Smith argued, reduce the suffering that bad harvests cause by inducing consumers to start economizing early."


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