The scientific way to measure the value of speculators in wide markets is to consider the bull as one whose purchases in times of falling prices serve to minimize the decline, and the bear as one who serves a doubly useful purpose in minimizing the advance by his short sales and in checking the decline by covering those sales. All these operations serve useful economic purposes, since the more buyers and sellers there are, the greater the stability of prices and the nearer the approach of prices to values.
This, as I have said, is the scientific way to look at it, and the correct way, but the popular way is something quite different. From this point of view the man who sells property he does not immediately possess is thought to be a menace, who depresses prices artificially and works a disadvantage to the investor or, in the produce markets, to the producer. Nothing could be more fallacious than this, because of the fact that just as every routine sale of actual stock requires a buyer, so every short sale by a bear requires a purchase by him of equal magnitude. And it is precisely these repurchasing or “covering” operations of the bears that do the utmost good in the way of checking declines in times of panic or distress.
When there are no bears, or when their position is so slight as to be inconsequential, declines are apt to run to extreme lengths and play havoc with bulls. One often hears among acute and clever speculators the expression “the bears are the market’s best friends,” and, though this may seem incongruous, it is quite true. In the month in which these lines are written there has occurred, for example, a really severe break in prices on the Stock Exchanges at London, Paris, and Berlin, arising from the periodic Balkan crisis. This decline ran to disproportionate extremes, and, in fact, approached such demoralization that more than 300,000 shares of American securities held abroad were thrown on the New York market for what they would bring. The reason for the severity of this decline was easily explained. The outstanding speculative account at all European centres, while not actually unwieldy, was almost entirely in the nature of commitments for the rise. There was no bear account. Therefore all Stock Exchanges were supersensitive since they lacked the steadying influence which covering by the bears invariably brings about. The bears are then, in truth the market’s best friends, and the more there are of them, the better for all concerned when trouble comes.
Throughout all the political agitation in Germany which culminated in that disastrous failure, the Bourse Law of 1896, there appears to have been very little opposition to the bear and the practice of short selling; nevertheless in that section of the law which prohibited dealings for future delivery the bears found their activities restricted. The law has now been amended, having proved a wretched fiasco, but in the decade which attended its enforcement it was curious to note the unanimous cry that went up in Germany for the restoration of the bear. His usefulness in the stock market no less than in the commodity market was recognized; his suppression was deplored. It was found that just as his activities were restricted so the tendency toward inflated advance and ultimate collapse was increased. The market became one-sided, and hence lop-sided; quotations thus established were unreal and fictitious. Moreover there was an incentive to dishonesty, for unscrupulous persons could open a short account in one office and a long account in another, and if the bear side lost they could refuse to settle on the ground customarily resorted to by welchers.
“The prices of all industrial securities have fallen,” said the Deutsche Bank in 1900, “and this decline has been felt all the more because by reason of the ill-conceived Bourse Law, it struck the public with full force without being softened through covering purchases”—i. e., by the bears. Again, four years later, when the law was still in force, the same authority states “a serious political surprise would cause the worst panic, because there are no longer any dealers (shorts) to take up the securities which at such times are thrown on the market.” The Dresdner Bank in 1899 reported that the dangers arising from this prohibition cannot be overestimated “if with a change of economic conditions the unavoidable selling force cannot be met by dealers willing and able to buy.”
“Short sellers do not determine prices,” says Professor Huebner. “By selling they simply express judgment as to what prices will be in the future. If their judgment is wrong they will suffer the penalty of being obliged to go into the market and buy the securities at higher prices. Nine tenths of the people are by nature ‘bulls,’ and the higher prices go, the more optimistic and elated they become. If it were not for a group of ‘short sellers,’ who resist an excessive inflation, it would be much easier than now to raise prices through the roof; and then, when the inflation became apparent to all, the descent would be abrupt and likely unchecked until the basement was reached. The operations of the ‘bear,’ however, make excessive inflation extremely expensive, and similarly tend to prevent a violent smash because the ‘bear,’ to realize his profits, must become a buyer. The writer has been told by several members of the New York Stock Exchange that they have seen days of panic when practically the only buyers, who were taking the vast volume of securities dumped on the exchange, were those who had sold ‘short,’ and who now turned buyers as the only way of closing their transactions. They were curious to know what would have happened in those panic days, when everybody wished to sell and few cared to invest, if the buying power had depended solely upon the real investment demand of the outside public.
“In reply also to the prevalent opinion that ‘short selling’ unduly depresses security values, it should be stated that ‘short sellers’ are frequently the most powerful support which the market possesses. It is an ordinary affair to read in the press that the market is sustained or ‘put up’ at the expense of the ‘shorts’ who, having contracted to deliver at a certain price can frequently easily be driven to ‘cover.’ Short selling is thus a beneficial factor in steadying prices and obviating extreme fluctuations. Largely through its action, the discounting of serious depressions does not take the form of a sudden shock or convulsion, but instead is spread out over a period of time, giving the actual holder of securities ample time to observe the situation and limit his loss before ruin results. In fact, there could be no organized market for securities worthy of the name, if there did not exist two sides, the ‘bull’ and the ‘bear.’ The constant contest between their judgments is sure to give a much saner and truer level of prices than could otherwise exist. ‘No other means,’ reports the Hughes Committee, ‘of restraining unwarranted marking up and down of prices has been suggested to us.’”[31]
So much for the functions of the bear in markets that deal in invested capital. In the commodity markets he becomes of even greater value, indeed, he is well-nigh indispensable. Mr. Horace White, who was the Chairman of the Hughes Investigating Committee, cites this instance: “A manufacturer of cotton goods, in order to keep his mill running all the year round, must make contracts ahead for his material, before the crop of any particular year is picked. The cotton must be of a particular grade. He wishes to be insured against fluctuations in both price and quality; for such insurance he can afford to pay. In fact he cannot afford to be without it. There are also men in the cotton trade, of large capital and experience, who keep themselves informed of all the facts touching the crops and the demand and supply of cotton in the world, and who find their profit in making contracts for its future delivery. They do not possess the article when they sell it. To them the contract is a matter of speculation and short selling, but it is a perfectly legitimate transaction.
“To the manufacturer it is virtually a policy of insurance. It enables him to keep his mills running and his hands employed, regardless of bad weather or insect pests or other uncertainties. The same principles apply to the miller who wants wheat, to the distiller, the cattle-feeder, and the starch-maker who wants corn, to the brewer who wants hops and barley, to the brass founder who wants copper, and so on indefinitely. Insurance is one of two redeeming features of such speculation; and the other, which is even more important, is the steadying effect which it has on market prices. If no speculative buying of produce ever took place, it would be impossible for a grower of wheat or cotton to realize a fair price at once on his crop. He would have to deal it out little by little to merchants who, in turn, would pass it on, in the same piecemeal way, to consumers. It is speculative buying which not only enables farmers to realize on their entire crops as soon as they are harvested, but enables them to do so with no disastrous sacrifice of price. When buyers who have future sales in view compete actively with each other, farmers get fair prices for their produce.”[32]
And, it may be added, the same satisfactory result is attained when bears who have sold the farmer’s crop short come to cover their short sales by buying in the open market; their buying steadies the market if there is a tendency to decline; if the market is strong, their buying helps make it stronger. In either case they are the farmer’s best friends, because the farmer profits as prices advance.