In Defense of Speculators

STEVE H. HANKE

September 11, 1992|By STEVE H. HANKE

During his first 10 years as a world-class speculator, MichaelMarcus parlayed $30,000 into an $80 million fortune.

Ah, but critics of the free-market system want to know: ''What good are you doing for society?'' Maybe someone will ask Mr. Marcus that today, when he returns to speak at his alma mater, the Johns Hopkins University.

Market haters portray financial innovators and entrepreneurs as paper-pushing, tape-watching profit maximizers who exist only to exploit the working man. Typical is Oliver Stone's 1987 motion picture ''Wall Street,'' in which a character offers this advice: ''Create, instead of living off the buying and selling of others!''

The Chicago futures markets, where Mr. Marcus practices his trade, are a favorite target of those who abhorred the 1980s' ''decade of greed.''

Criticisms of futures markets are not recent. Since the first congressional legislation on futures markets was introduced, more than 200 bills have been proposed to limit, prohibit, tax or regulate commodity-futures markets. In 1947, President Truman used speculators as a whipping boy, blaming ''gambling in grain'' for high food prices. ''Grain prices naturally respond to the law of supply and demand,'' Truman said, ''but they should not be subject to the greed of speculators who gamble on what may lie ahead in our commodity markets.''

It's surprising that Bill Clinton didn't pick up on that populist theme in his Labor Day speech delivered in Truman's hometown of Independence, Missouri. The governor has certainly had enough to say about the ''greed'' of the 1980s.

Why do futures markets receive so much criticism? It is because what is not understood is often condemned. Mankind is reactionary. The new, the novel and the unusual are rarely honored in their day. Today's futures speculators and arbitrageurs were yesterday's dairymen and warehousemen. In their day, transportation and storage were viewed as suspiciously as today's innovative financial markets.

Adam Smith's discussion of the Corn Laws in ''The Wealth of Nations'' tells that story. Smith, who wrote in 1776, reviewed public attitudes toward two new forms of wealth creation:

''forestalling'' and ''engrossing.''

''Forestalling'' involved corn purchases in times of plenty in the hope that corn could later be resold at a profit. ''Engrossing'' focused on price differentials between different locales within England. For example, engrossers bought low in Birmingham and sold high in London -- or so they hoped.

These activities were soundly criticized as the sterile business of middlemen interested only in profiting at the expense of the consumer. They produced no new corn, and supposedly they raised prices. Such speculation, the conventional wisdom held, could only hurt the general public.

With his usual eloquence, Smith explained that, far from being mere profiteers, middlemen played an essential role.

If the speculators bet on scarcity, but scarcity failed to materialize, they would be forced to resell their product at a loss. Even if the price remained the same, the speculators bore the costs of storing or transporting the commodity.

When scarcity occurred, however, Smith explained that ''the best thing that can be done for the people is to divide the inconveniences of [that scarcity] as equally as possible through all the different months and weeks and days of the year'' and, of course, across the nation.

Smith noted that corn traders were the most appropriate party to carry out this ''most important operation of commerce.''

Moreover, he wrote, the risks were clearly shifted from consumers to speculators. When engrossers and forestallers were wrong and prices fell rather than rose, they bore the consequences of their errors. On the other hand, when they were correct and shortages did occur, both they and the citizenry benefited.

Smith stated that ''after the trade of the farmer, [there is] no trade contributing so much to the growing of corn as that of the corn merchant.'' Not only did corn traders provide the service of BTC corn transportation and storage for consumers, but they saw to it that the corn ultimately came to market. Absent such speculators, farmers themselves would have been forced to bear the risks.

Smith continued, ''The popular fear of engrossing and forestalling may be compared to the popular terrors and suspicions of witchcraft. The unfortunate wretches accused of this latter crime were not more innocent of the misfortunes imputed to them, than those who have been accused of the former. . . . The corn trade, so far at least as concerns the supply of the home market, ought to be left perfectly free.''

When the critic decries the lack of social value in paper-pushing, profit-maximizing speculative activity, he shows his lack of understanding of how markets function. When crusading politicians and prosecutors seek to limit speculative activity, it is also out of ignorance of the benefits of these activities.

As Adam Smith's account shows, popular opinion in his day failed to understand that many more people in England would have starved without speculators to help ration scarcity.

And today, the modern counterparts of Smith's forestallers and engrossers are chastised for their lack of social value, although they perform the same service more efficiently.

When the Hopkins community applauds Michael Marcus today, it should recall that, as a world-class speculator, he has done well by doing good.

Steve H. Hanke is professor of applied economics at the Johns Hopkins University and a contributing editor to Friedberg's Commodity and Currency Comments.

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