Speculation is investment in the hope of capital gain rather than income gain. Many people consider speculators dangerous and, when the market loses its stability, some politicians make speculators the scapegoats for the crisis and try to regulate the market. Are they really responsible for it?
1. Speculators stabilizes the market.
The more unstable the market gets, the more chances to earn money speculators can grab at. But it does not follow from it that the speculators make the market unstable. So long as the market mechanism works well, no speculators can personally control the market at their will.
All that the speculators can do is to guess ahead. When a price of capital is relatively low, they buy in the hope of a future rise and, when their prospect proves true, they sell it. When the price is relatively high, they make a short sale in the hope of a future drop and, when their prospect proves true, they buy it back. If speculators buy anything overvalued and buy anything undervalued, they will have their funds quickly run out and be weeded out of the market. This shows that, so long as speculators are making money, the market will go neither overvalued nor undervalued.
2. The paradox of beauty contest
Some doubt this criticism of common sense, pointing out the paradox of beauty contest. Here the beauty contest means such as to put the choice of beauties, whose pictures appear in the newspaper, to the vote by its readers and award a prize to those who voted in favor of the beauty that obtained the most votes. In order to win the prize, the readers must think about, not who the beauty is but who the others think the beauty is, who the others think the others including me think the beauty is and so on. This regressus in infinitum of the forecast, it is said, makes the forecasting game indeterminate and most of the readers come to vote for a woman they do not estimate to be beautiful.
It is true the market would be unstable, if, owing to the paradox of beauty contest, many speculators should continue buying/selling what they themselves feel overvalued/undervalued. But I would like to criticize this criticism of the criticism of the common sense in terms of two points.
First, the regressus in infinitum of the forecast does not make the forecasted price diverge. Let a present price be p0, the nth forecasted fluctuation of the price dpn and the probability of the forecasts r (0<r<1). Then the forecasted price is
This infinite series converges.
Second, forecasting the forecast does not amplify but correct the detachment from fundamentals caused by the beauty contest style forecast. A bubble/panic often comes about when participants in the capital market, though they themselves feel it overvalued/undervalued, forecast the other may not feel so and go on buying/selling. But when they forecast that the others go on buying/selling, though they themselves feel it overvalued/undervalued, just because they forecast the other may not feel so, they switch to a sell/buy. It results in correcting the valuation disparity.
3. Speculators as scapegoats
Thus, speculators contribute to stabilizing the market, though they just pursue their own interests. Just as Hitler once targeted the international Jewish financiers, current nationalists scapegoat speculators such as George Sores as the agents of global market economy and try to gain support from the domestic masses. But, don’t mistake the real cause of economic crises.