Tuesday, June 3, 2014

In Defense of Speculators

NOTE: These seven essays were reproduced from my defunct blog Random Notes as they will be cited in my soon to be posted essay on common sense and pragmatism.

I have read recently many blaming "speculators" for driving up oil prices. Unfortunately even conservatives seem to be prone to this economic fallacy. People always criticize speculators, though I often think it is more envy than anything else. Even if it isn't, it just shows a horrible lack of economic understanding.

Speculators do not drive up prices. Or, to be accurate, they drive up prices when prices are too low and drive them down when prices are too high. The basic purpose of speculation is to cause prices to level out.

How does that work?

Speculators buy and sell based on where they expect the market to be in the future. Those that bet right tend to accumulate more money and so the best predictors tend to control the bulk of the resources. Thus, thos ewho sell when prices are high, thus driving down prices, tend to make money, while those who buy when prices are low, thus driving up prices, tend to make money as well.

Speculators right now are buying as the market is still rising. This seems to be driving up prices, and it is, but only in the short term. As demand continues to rise, the final market price will be higher than the current price, so speculators are buying.

So, why is this not harmful? Because to actually make money, speculators will eventually have to sell, and that will lower prices when prices are even higher. Thus the speculators will serve to keep the final price lower than it would be without their intervention.

Unfortunately, when the selling of speculators lowers the market price, they are villifed for their "obscene profits" and when they buy and drive up prices they are villified for "driving up prices".

The truth is the price is determined by supply and demand, not speculators. Speculators just serve to level out the bumps int he market and keep prices consistent. They are not responsible for the current price rise, the rise in demand without a commensurate increase in supply is. And, though it may seem horrible that speculators are driving up prices now, when they lower prices later on it will be appreciated, though I doubt anyone will thank the speculators.

Originally posted in Random Notes on 2008/06/27.

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