Financial Speculators Aren't Just Gamblers
Speculating and gambling have often been conflated as the same thing. However, the line between them has an important history that shows the value of dissent.
Financial speculators have long been looked down upon as gamblers in the financial markets, and that’s not completely false. Many people buy speculative investments and hope their prices increase. These people don’t learn about the investment they’re making.
However, some speculative investments can serve useful purposes. Futures allow speculators to guess whether an asset’s price will go up or down. These investments were created for American farmers to use as insurance.
There’s no single insurance policy that can cover losses from the full chain of agricultural production. No actuarial table can cover the risks of:
Low crop yield
Transportation risks
Storage malfunctions
Transportation risks again
Distribution variances
Setting aside money for a price decrease can function like insurance. The farmer puts money aside in case of a disaster. If disaster strikes, then the farmer gets some money back. The tradeoff is that this insurance function is fuelled by money from people using financial exchanges as gambling platforms.
Stuart Banner’s book, Speculation, offers a history of the line between speculation and gambling. That line can be fuzzy, but understanding it clarifies the madness of financial manias and panics.
Speculators Are Double-Edged Swords
Financial speculators can put more money in a market, so more people can trade within it. Speculators can also stabilize prices when they bet on a price falling, as they do when they short stocks.
However, the bankruptcies they inflict on themselves and others can be destabilizing, as it was during the 2008 Great Recession.
“This is the dilemma,” Banner wrote. “The more we give speculators free rein, the greater the risk that speculators will bring harm to others. But the more we constrain speculators, the smaller the benefits of speculation.”
The policy dilemma isn’t the only one. Banner points out a moral one, too:
“Speculation has long been decried as immoral - a method of profiting by impoverishing others, a device for making money without performing any useful service, and a scheme rigged by crafty insiders to exploit the ordinary person.” Banner goes on to point out that “this moral debate is connected to the economic debate, because some of the moral critique of speculation has always rested on the belief that speculators are not providing value to society in the same way that producers are.”
The moral cases against speculators are similar to the ones made against gamblers. Gambling was seen as a self-destructive vice that encouraged laziness, led to bankruptcy, and sometimes suicide.
However, the differences between speculating and gambling were useful and important.
Speculating Can Be Useful. Gambling Is Just Entertaining.
One of the ways that Banner separates investing from gambling is whether there’s a long or short-term interest in an asset or a venture. He quotes Alexander Hamilton who wrote of early American stockholders that “‘tis time there should be a line of separation…between respectable stockholders and dealers in the funds, and mere unprincipled Gamblers.”
Another was “the degree of risk” that an investment carried. Every investment carries some risk, but ignoring any semblance of strategy is guesswork. Entrepreneurs may accept risk, but they also mitigate risk where they can to maximize their chances of success.
Finally, investments can be positive-sum transactions instead of zero-sum. Investing in a startup could create something more valuable than the vacuum it previously occupied. Hoping that the price of a venture will rise without any due diligence is a vain hope in luck or that someone else will buy the investment instead.
These are guidelines that place purchases on one side of the line between gambling and speculating, but the line remains fuzzy.
Who Do We Want To Speculate?
About halfway through the book, Bannon brings up an argument about commodity speculation in agriculture from the 1890s. He quotes a broker, Alexander Hudnut, who wonders who we should want to do the speculating:
“The broker Alexander Hudnut pointed out that someone had to bear the risk that commodity prices would decline. If it wasn’t a speculator it would be the farmer, and in that case, the farmer would be speculating just as much as any trader on an exchange. If there were no speculators in the chain of distribution, farmers would have to become speculators themselves.”
When wondering whether speculating should be allowed or roped in with gambling, it’s worth remembering that speculators do useful things. They’re one of the reasons that financial markets have so much money in them. Speculators stabilize prices when they get too high, which prevents bubbles and crashes.
It makes more sense to leave speculating to a group of people who choose to do it rather than the sliver of people who use speculating tools to hedge instead of gamble.
I was a reporter covering the sports betting industry and learned a lot from this book. There’s so much fascinating history, philosophy, and financial theory in this accessible and clearly written book.