The Social Function of Stock Speculators

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Libertarian economists typically adopt a two-pronged approach in their advocacy of free markets. On the one hand, they stress that people have rights (whether God-given or self-evident from the exercise of reason) and therefore should be able to engage in any voluntary activities with each other, free from political interference. Unfortunately, this appeal to principle is never enough, since the type of person who votes for today’s politicians doesn’t care much about abstractions.

This leads to the second prong of the argument: The use of economic science to demonstrate unnoticed and often counterintuitive benefits from activities that the common man despises. For example, after pointing out that the government has no business sticking its nose into capitalist actions between consenting landlords and renters, the libertarian might use economic theory to illustrate the disastrous effects of rent control. After all, the right to property is (rightly or wrongly) easier to appreciate when populist violations of it lead to housing shortages.

It is in this spirit that I offer the present essay, an examination of the social benefits of stock speculators. Now when it comes to different ways of making a living, stock speculation certainly wouldn’t make the Top Ten Most Altruistic among Oprah Winfrey viewers. Indeed, even among people who think that middlemen perform vital services in tangible commodities — such as buying oranges low in Florida, and selling them high in Alaska — there seems to be something artificial about transactions involving nothing more than electronic swapping of shares to corporations. Even among people who ought to know better, there is a presumption that stock speculation is a zero-sum game, and that if one person buys low and sells high, his gain only comes at the expense of someone else, leaving society on net exactly the same.

Speculators Correct False Prices

Speculators are out to make money, to buy low and sell high, as the cliché goes. What this truism entails, however, is that the successful speculator — who can consistently buy low and sell high — can predict certain stock prices better than others, and indeed even better than others who are risking money on those very stocks. For example, if a speculator buys at $100 on Monday and sells at $110 on Friday, he was only able to do this because other people in this very market didn’t realize on Monday that the stock would appreciate so quickly. (If they did, they wouldn’t have sold for $100. They would have held onto the stocks and netted the gain themselves.)

If this were the whole story, then stock speculation might truly be a zero-sum game, where the lucky or farsighted enrich themselves at the expense of the unlucky or dimwitted. This isn’t the case, however, because in the very process of profiting from their superior vision, stock speculators influence stock prices. When stock prices are undervalued, the successful speculator buys shares, an action that drives up the prices in question. In contrast, if a stock is "overvalued" — and by this term we mean nothing deeper than that the stock will fall in price more quickly than others in the market realize — then the successful speculator may "short sell" it, or engage in comparable actions (such as buying a put option) that tend to push down the share price.

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Bob Murphy [send him mail] runs the blog Free Advice.

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