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Should Speculation be Regulated?

Many believe that speculation is largely responsible for the present economic crisis. They suggest that our desire to speculate and our appetite for quick profits caused us to act cavalierly and irresponsibly with regard to risk, blinded by the hope of making big gains quickly. Speculators don’t create or produce anything. All they do is buy and sell shares, houses or commodities, in order to profit from price changes. They all have their own methods for trying to predict the future price of the assets they speculate in. Some prefer fundamental analysis, others look at technical factors, and yet others opt for a combination of the two. Regardless of the method, their sole objective is to make profits.

Speculators spend their lives predicting supply and demand for a commodity or a financial product. If their predictions are right, they make a profit. According to the argument put forward to justify speculation, the pooling of the results of the analyses of all the speculators makes the economy more productive. Speculators’ positioning in the market is highly indicative of the consensus that exists on the dominant trends in each sector. This consensus affects the prices of the products speculated on. The positions that speculators take reflect changes in consumer attitudes and the impact of new technologies, and they are very useful to production managers at the planning stage. If, for example, speculators anticipate a difficult winter in a major wheat-producing country, they will massively buy wheat futures contracts, thereby pushing up the price of wheat. Consequently, regions with less harsh weather conditions will produce more wheat, which will reduce the worldwide shortage of this grain. With their actions, speculators increase the liquidity of the markets they deal in, thus enabling the real players to hedge at better prices.

If speculators’ actions are beneficial, why are regulators constantly trying to regulate speculation to better control its impact? In 2008, for example, the price of oil hit $147 a barrel. Many analysts predicted a period of oil shortages and an explosion in the price of oil to $300 a barrel. Speculators who sold short at that time made a fortune. The market rewarded the speculators who were right. Combined with lower consumption and an increase in production, their sales helped bring down the price of oil to close to its real value, more quickly than any regulation could. When oil prices exceed a certain level, demands to regulate the price increase. Regulators then want to substitute the fairprice concept for the judgment of many producers, consumers and speculators. Regulation prevents the market from functioning by not allowing the price to reflect all the available information. In the 1970s, oil prices were fixed and speculation was prohibited. The result was catastrophic, with decreased production resulting in endless line-ups at the pump. In the early 1980s, the price of oil was deregulated and speculation was allowed again; both prices and production then adjusted.

Opposing regulation of speculation does not mean we should let anything go. We still need rules to prevent fraud, theft and criminal activity. The major exchanges are also subject to rules to protect investors and traders, such as maintaining minimum margin requirements, for example. However, governments should not substitute the judgment of a few bureaucrats for that of millions of market participants.

If we let speculators speculate, they should fully assume the consequences of the risks they take. If they enjoy all the benefits of the risky trades they engage in, they should also accept the downside of losing trades. When governments have to bail out financial institutions, as they did recently, the institutions aren’t paying the consequences of the risks they took. Speculation should help make the market more efficient. It should not be done in secret between two parties, without transparency.

As we can see, speculators’ actions can be beneficial, but they should still be subject to some form of control, which is far from simple.

The author

Marc Desnoyers

Marc Desnoyers

B.Sc., M.B.A., C.F.A