The Stock Exchange from Within

by William C. Van Antwerp

Now go a step further, and we find that the managers of these railways, mines, and factories, are in turn dependent—wholly dependent upon capital. They cannot go ahead with the extensions and improvements necessary to efficiency without borrowing money; and credit, in turn, will not come to their support unless a broad market is provided, through the Stock Exchange, for the securities which represent these obligations. Hence we see that just as every farmer in the West and every cotton-grower in the South must have a stable market for his products, so every laborer in our great industrial field is directly concerned with the maintenance of a stable market for the securities of the company that employs him. The interests of one are the interests of all, and speculation, in one form or another, underlies all industrial progress. “Complaint is made of the evils of speculation,” said the greatest of French economists, “but the evils that speculation prevents are much greater than those it causes.”[18]

Now that we have reached a point in our discussion that brings us face to face with the so-called “evils” of speculation on the Stock Exchange, let us pause and consider the difference between speculation, which is held by many to be abhorrent, and investment, which is generally thought right and proper. The first thing we encounter is the shadowy and indistinct boundary line that separates the one from the other. Does any one know where the one begins and the other ends? France has more conservative investors than any other country, yet, as Mr. Hirst puts it, the most critical and hidebound buyer of French rentes is a speculator in the sense that he not only wishes his purchase to yield him interest, but also hopes and expects that sooner or later he will be able to sell out at a profit, all of which is legitimate, proper, and human. The first question every man asks when the time comes to invest is, “Is this a good time for investment?” “Am I buying cheap?” by which he means “Are these investments likely to enhance in value?”

He may have bought Spanish bonds at low prices during the war between Spain and the United States—a somewhat speculative investment—and in his purchase he believed himself an investor in a strict sense. Yet, when those bonds recovered to a normal basis and he sold out at a profit, was it speculation, or investment, or a little of both, that defined the trade? British consols are low to-day, and there is of course no safer investment, but the investor who buys them is influenced by the fact that a long period of peace seems to lie ahead, with reduced expenditures for armament and hence with diminished borrowings by the Government leading to a substantial recovery in the price of these solid securities. Such a man is “speculating” on England’s abstention from war, on its limitation of military and naval expenditures, and on the probable effects of these matters on the price of his consols.[19]

The truth seems to be that all investment is speculation, differing from it in degree but not in kind. This salient fact was recognized as long ago as 1825, when, despite the comparatively limited field for investment enterprise, McCulloch saw what was coming and grasped the true idea of the part speculation and its handmaiden, investment, were to play in the industrial renaissance. Coming at a time when speculation was new, and subjected, as all innovations are, to widespread criticism and doubt, his words have prophetic significance.

“It is obvious that those who indiscriminately condemn all sorts of speculative engagements have never reflected on the circumstances incident to the prosecution of every undertaking. In truth and reality they are all speculations. Their undertakers must look forward to periods more or less distant, and their success depends entirely on the sagacity with which they have estimated the probability of certain events occurring, and the influence which they have ascribed to them. Speculation is, therefore, really only another name for foresight; and, though fortunes have sometimes been made by a lucky hit, the character of a successful speculator is, in the vast majority of instances, due to him also who has skilfully devised the means of effecting the end he had in view, and who has outstripped his competitors in the judgment with which he has looked into futurity, and appreciated the operation of causes producing distant effects.”[20]

A quarter of a century later we find England’s foremost thinker sounding the same clear note. John Stuart Mill was by no means a hermit philosopher feeding on theories. Traveler, sportsman, business man, statesman, and author, he saw things broadly and wrote for practical men. “Speculators,” he said—and he was speaking of the “greedy” ones who buy and sell for gain—“have a highly useful office in the economy of society. Among persons who have not much considered the subject there is a notion that the gains of speculators are often made by causing an artificial scarcity; that they create a high price by their own purchases and then profit by it. This may easily be shown to be fallacious.” He then shows, what I have outlined elsewhere, that the market is larger than any speculator or group of speculators, and, if this was true in 1848, I think it will not be disputed that it is quite true to-day.

Continuing, Mill says: “The operations of speculative dealers are useful to the public whenever profitable to themselves. The interest of the speculators as a body coincide with the interests of the public; and as they can only fail to serve the public interest in proportion as they miss their own, the best way to promote the one is to leave them to pursue the other in perfect freedom. Neither law nor opinion should prevent an operation, beneficial to the public, from being attended with as much private advantage as is compatible with full and free competition.” Mill makes no distinction here between investors and speculators; they are one and the same. In any case it is conceded that speculation is what makes the markets to-day, since 90 per cent. of the transactions that take place daily on the world’s Stock Exchanges are speculations pure and simple. And this is a good thing. Before we go on with our subject, let Professor Emery explain why, and bring the teachings of McCulloch and Mill down to our own day:

“Speculation has become an increasingly important factor in the economic world without receiving a corresponding place in economic science. In the field in which it acts, in the trade in grain and cotton and securities and the like, speculation is the predominant influence in determining price, and, as such, is one of the chief directive forces in trade and industry. But treatises in the English language on general economic theory and conditions have given very little space to this influence, which is fundamental in the world of economic fact....

“It is true that forty years ago speculation was far less important than it is now, and there was, therefore, more justification for disregarding it. Professor Hadley has given due consideration to the new conditions which prevail in modern business. At the same time it should be remembered that McCulloch, already in his day, had grasped the true idea of the function of speculation, a fact shown by the incorporation of his treatment of the subject into his chapters on Value. Wide as is the influence of speculation, its force is felt primarily in the field of prices. By making prices it directs industry and trade, for men produce and exchange according to comparative prices. Speculation then is vitally connected with the theory of value.

“From the point of view of theory, therefore, it is incorrect to attach so little importance to the function of speculation; in practice it is impossible to deal intelligently with the evils of the speculative system without first recognizing its real relation to business. Both the writer and the reformer must reckon more than they have yet done with the fact that speculation in the last half century has developed as a natural economic institution in response to the new conditions of industry and commerce. It is the result of steam transportation and the telegraph on the one hand, and of vast industrial undertakings on the other. The attitude of those who would try to crush it out by legislation, without disturbing any other economic conditions, is entirely unreasonable.”[21]

Now we come to the evils of the business. That there are evils, really serious ones, no one will deny. To be sure many of the phases of speculation that are called evils are not evils at all; the statements made concerning them have what Oscar Wilde termed “all the vitality of error, and all the tediousness of an old friend,” and yet, although the prevalent criticism is often stupid and superficial, there are undeniably offensive forms of speculation that one would like to see suppressed. Speculation is a comparatively new phenomenon, and it has brought with it dangers and pitfalls. So also have automobiles, electricity, and steam engines. But while the Stock Exchange has created the arena for the display of these abuses, it has not originated them “except,” as a recent writer puts it, “in the sense in which one may say that private property has originated robbery.”

The great evil of speculation consists in the buying of securities or real estate or anything else with borrowed money, by uninformed people who cannot afford to lose. Its commonest form in speculation in securities is what is known as “margin” trading, this name being derived from the fact that the buyer, instead of paying cash in full for his purchase, deposits only a fractional amount of its cost, which is intended to serve as a margin to protect the broker from loss, while the broker pays the remaining sum necessary to complete the actual purchase. Thus the speculator may deposit $1000 on securities costing $10,000, while the broker furnishes the additional $9000. It is a system in use everywhere; on the London Stock Exchange it is called “Cover,” on the Paris Bourse, “La Couverture.”