VI. SPECULATION AND CRISES.
An unavoidable element of risk enters into all modern business. In the old handicraft stage of industry goods were made upon order; demand preceded supply very definitely, and there was little possibility of mistakes in production. Nowadays, as we have seen, production is for a distant and often uncertain market. It is carried on by machine methods and roundabout processes; sometimes the result is a very remote one and the uncertainty of success is correspondingly great. Production is not based upon order, but upon a forecast of the possible demand, upon a future market. Chance and change are inseparable from productive enterprise—natural chances from the elements, political changes, as war or unfavorable legislation, industrial mistakes or sickness or death of oneself or others, and economic changes, as the invention of a new machine or a change in fashion. These are the unavoidable incidents
in industry and are not under the control of the individual business. Some of them, however, are so regularly recurrent that they can be foretold on a large scale for any industrial society, and can be guarded against by insurance. Everyone recognizes the desirability of having such risks as those of fire, shipwreck, lightning, death, etc., assumed by certain individuals or companies who make a business of such risk-taking. A small premium is paid by the individual for protection, and he is freed from anxiety from mischance and is able to devote his whole energies and capital to his business; the insurance company has specialized in this one department and by equalizing the chances over a wide field has practically eliminated them. In doing this it performs a service of recognized and undoubted social value.
There is another kind of risk-taking the social utility of which is not at first sight so clear. Among the chances of productive enterprise are those due to the rise and fall in the prices of the raw materials, the labor, and the finished product between the time when the process of production is begun and the time when it is completed. Every farmer, every manufacturer, every student even who invests capital in his own education, is to some extent a speculator. Along certain lines he can protect himself by insurance, but that is not possible in all. Is there no way, then, by which he can guard himself against price fluctuations and assure himself of the legitimate gains of his business? This, it may be answered, is the function of the speculator in modern business, and in performing this service he is benefiting society in much the same way that the insurance company does. We must, however, clearly distinguish between legitimate and illegitimate speculation; we are discussing only the former.
One way in which the speculative risk attaching to price fluctuations is reduced for the manufacturer and assumed by the speculator is by the establishment of a continuous
open market, as the stock and produce exchanges. If a miller, for instance, engages to deliver flour a year hence and expects to begin milling in six months, he must know at what price he can buy his wheat when he needs it, or his anticipated gain may be turned into a loss by an unexpected rise in the price of wheat. He is able, however, to buy a “future” in wheat on the produce exchange from some broker who makes a specialty of this business. He buys his needed wheat now for delivery six months hence, and on the basis of this price is able to accept an order for his flour a year from now, allowing himself a fair profit as a miller but wholly eliminating the speculative risk of price fluctuations. Or a building contractor, before making an estimate of the cost of erecting a structure, will secure options at definite prices from dealers on the materials he will require. So, too, in the iron and steel business it is customary for manufacturers to contract in advance for materials at the same time that they accept orders for the delivery of the finished products. In all these cases the business of dealing in futures is assumed by a particular class, who have developed a special skill and ability in forecasting price variations, and who can do so very accurately. It is not a matter of luck or chance, but the result of wide knowledge and careful study. “To foretell the price of wheat one must know the rainfall in India, the condition of the crop in Argentina, must be in touch as nearly as possible with every unit of supply that will come into the market.” Sometimes the speculators make mistakes, but they are certainly less apt to do so than men who are without their special talent and training.
The social value of this service lies in the equalization of demand and supply between the present and future that is thereby effected. Let us take as an illustration the case of the miller cited above. If at the time he accepts the order for flour the price of wheat is high, he will be inclined to charge a high price. But the wheat broker,
foreseeing that there is going to be an abundant crop six months hence, engages to sell him his wheat for future delivery at a low price, and he is thereby enabled to sell his flour at a lower price. At the same time the price of the wheat on hand at the present time, instead of being held and sold at famine prices, is consumed for present needs at moderate prices. The operations of the wheat brokers in such a case have a very steadying influence on prices, preventing the oscillation between very high prices in times of scarcity and very low prices in times of glut. It must be admitted that dealings in futures are highly speculative; “but it must be remembered that it is not merely the dealings in futures, but the future itself, that is uncertain. If such dealings can be confined to the men most competent to make accurate predictions, their tendency will clearly be to lessen the uncertainties of business.”[8] But closely connected with legitimate speculation or risk-taking by a specialized and trained class, there is, as our stock and produce exchanges are actually conducted, a large amount of illegitimate speculation, and to this we may now turn for a brief consideration.
The facilities offered by the open markets on the exchanges and the practice of dealing in futures are taken advantage of by many who, without any special training or opportunities of knowing the market, simply bet on the price movements. Brokers are willing to buy and sell produce or stocks for their customers if the latter will put up with them a margin of about 10 per cent to protect them from loss. It is therefore possible for a person with little capital and no knowledge to speculate on a margin, buying what he does not want and selling what he does not own. In practice it is impossible to distinguish between those dealings in which actual delivery is intended (legitimate speculation) and those in which no such delivery is contemplated (gambling), and consequently most efforts to
regulate transactions on the exchanges have failed to accomplish their purpose. The purification of their methods would seem to lie with the members of such exchanges themselves. The contention has often been made that these fictitious transactions in such commodities as wheat or corn or cotton create an artificial reduction in prices, since the professional gambler usually sells short or “bears” the market, and that this injuriously affects the farmer. This is manifestly untenable, since every fictitious sale must be balanced by a fictitious purchase. What actually takes place is simply a bet between the two parties to such a transaction on the actual course of prices and of itself does not affect prices, except in the unusual case of a “corner.” There is, however, great possibility of evil in the presence of a crowd of uninformed speculators, for they can greatly increase the power of an unscrupulous operator who can persuade them to follow his lead. Their presence, too, increases the temptation to such a man to rig the market. Under present conditions the abuses of speculation are more in evidence than the economic advantages. How to confine speculation to the small group of risk-takers who have special training and aptitude for it, and to prevent gambling on the stock and produce exchanges is one of the economic problems of the day.