The truth about speculators: they are doing God’s work

In which Paul Murphy sorts the truth from the claptrap

There’s a lot of claptrap going around right now about the way financial markets operate. That’s claptrap in the purest sense: words designed to win applause or impress the public.

Witness François Fillon, the French prime minister, rushing to Berlin to meet the German chancellor, Angela Merkel, so they could both sit down and write a letter to José Manuel Barroso, asking the European Commission president to investigate this and ban that. In Basel, meanwhile, Mario Draghi, chairman of the Financial Stability Board, has just promised a generalised clampdown and something he called “systemic regulation”.

“Speculators” are in the frame. Every day, it seems, a politician or senior official from somewhere across Europe spits out the dirty word “speculators” and then proceeds to demand immediate action, retribution, or both.

There’s never much detail in these attacks. No need for it. Speculation is bad, right? And if there is any detail, such as discussion of those dreaded credit default swaps, there’s usually some mix-up about who’s doing the buying or selling or shorting or snorting or whatever people do these days with mutated derivatives.

No matter. Speculation is evil since speculators produce nothing of tangible value. Parasite Capital, LP. Case closed.

The populist rhetoric goes down well. Understandably, the people of Europe, staring austerity in the face, want someone to blame – and the notion that somebody, somewhere, is benefiting from their misery makes the blood of ordinary mortals boil. So the claptrap works. Good politicians are seen to be bringing the bad guys to heel, albeit belatedly.

The trouble is that speculation is to financial markets what claptrap is to the political system: absolutely crucial. Populist bombast grabs the attention of the electorate, it gets a politician known and, ultimately, ensures they get elected. Similarly, speculators, faceless or otherwise, make markets more efficient by providing the liquidity which makes trades possible and, ultimately, produce more accurate prices. They help us allocate capital as efficiently as we can.

How is it that our political elite does not know this? Have Europe’s leaders forgotten that we live in a market economy?

Clearly, there’s a need for an educational refresher on the matter.

Ms Merkel et al might like to start with an 80 year-old tome – Philip Carret’s classic from 1930, The Art of Speculation (reprinted 1997).

Yes, the contents pages alone might bring on a coronary in Athens, Berlin or Paris (“The speculator increases profits by borrowing money … Short selling is essential to an orderly market … The short seller does not injure the long trader”), but Carret’s prose is as elegant and instructive today as it was eight decades ago. A taste:

“Those who decry stock market speculation usually have stock market gambling in mind. The speculators are those who use brains as well as ink in writing the order slips for their brokers. They perform a service of substantial value to society.”

“Just as water always seeks its level, answering the pull of gravity, so in the securities markets prices are always seeking a level of values. Speculation is the agency by which the adjustment is made. Has a new industry arisen, filling a new demand, adding new wealth to society, requiring new capital in generous value? The alert speculator discovers it, buys its securities, advertises its prosperity to the investing public, provides it with a new credit base.”

“In this fashion the speculator is the advance agent of the investor, seeking always to bring market prices into line with investment values, opening new reservoirs of capital to the growing enterprise, shutting off the supply from enterprises which have not profitably used that which they already possessed.”

Carret teaches that speculators and speculation touch all parts of our lives – from high street retailers offering a new line of fashion to the hedge fund denizens of London’s Mayfair or Greenwich, Connecticut, taking a dim view on the stresses affecting European monetary union. Indeed, even the most conservative self-declared “investor” is always part-speculator.

More from his instruction manual:

“In fact, speculation is inseparable from investment. The investor must assume some degree of speculative risk; the intelligent investor will seek a certain measure of speculative profit. If he has the time, the temperament, the ability, the investor may go a step further and seek speculative profit in preference to dividend and interest income from his capital.”

“In doing so he is performing a valuable service to the investor, acting as his advance agent in seeking the most profitable channels of investment, increasing the marketability of investment holdings, helping to support the financial machinery which is designed primarily for the service of the investor.”

Carret, we should note, was no market spiv. But he did take the risk of setting up one of America’s first mutual funds, the Fidelity Investment Trust, which later became better known as the Pioneer Trust. He died 12 years ago at the age of 101.

His teachings are as relevant now as ever. Greece, Italy, the UK and others under supposed “speculative attack” are in that position because there is a view that they are “falling upon evil days”.

“Advance agents” are telling us that there are problems with too much public debt in the western world, and simply legislating or regulating those agents out of the way is not going to fix things.

What Carret is pointing out is that speculators tell us the truth about what is happening or is likely to happen soon. For a number of European governments, the truth is a little too much to bear right now.