Why We Need More Speculators

Greek prime minister George Papandreou demands a crackdown on credit default swaps. It’s easy to see why politicians bring up wicked speculators whenever some economic hardship shows up. It’s an old game to put the blame on others to deflect it from yourself.

Middlemen have been successfully pilloried for millennia. Ancient Athenians, faced with rising prices, hauled grain merchants to court some 2400 years ago. Could it be that throughout history speculators have messed up markets, hoarding wheat in ancient Athens and trading dodgy derivatives on post-modern Greek debt?

Indeed, they can become a problem if there are only a few of them.

The word “speculator” sounds derogatory, but it has a neutral, technical meaning. In commodity futures exchanges – the oldest and best established derivatives markets –  a speculator is a trader who is neither a producer nor a user of the commodity in question. Commodity producers and consumers protect themselves against price fluctuations with futures contracts that specify delivery at a certain price and date.

By contrast, speculators trade the contracts as an activity in itself. They typically do not deliver or take delivery of the physical commodity. These specialized middlemen mediate between future buyers and sellers, playing an essential role in meeting the needs of both sides.

Futures markets work smoothly and effectively because there is a large number of so-called “speculators.” If there were only one speculator, he could exploit people who need to buy or sell wheat—as would a group of speculators who act together. But there are many; they compete with each other and can’t fix the price.

The problem with the grain market in ancient Athens was that there were relatively few merchants. Regulators had the disastrous notion that grain importers should combine and form a cartel to buy grain cheaply. That caused higher prices. “Rather than blaming the regulators for these actions, the Athenians prosecuted the grain merchants for hoarding.”

At the trial, the prosecutor thus described the evil speculative acts: “For just when you find yourselves worse off for [grain], these persons snap it up and refuse to sell it, in order to prevent our disputing the price: we are to be glad enough if we come away from them with a purchase made at any price, however high.”

Had there been a large number of independently acting merchants, Athenians could have shopped for the best price. But taxes, heavy regulations and threats like this trial – which may have resulted in the merchants being put to death – discouraged the grain trade.

Consider the current complaint about credit default swaps on Greek debt. The claim is  that a group of traders colluded to buy the instruments – a type of credit insurance – thereby pushing up the price of CDS and causing rates on Greek bonds to rise. The traders then sold off and pocketed the profit, leaving Greece with a heavier interest burden. That’s the allegation.

An early investigation found no sign of speculation on Greek debt.  But leave that aside. For traders to collude, there has to be a small number of them. If that is the case, then what’s needed is more traders in CDS. They will bet against each other and not have the power to manipulate prices.

Then again, politicians need scapegoats. They can’t very well say, we dug the economy into a hole by spending money like it’s free and that’s why we’re paying high interest on our bonds.

Disclaimer: This page contains affiliate links. If you choose to make a purchase after clicking a link, we may receive a commission at no additional cost to you. Thank you for your support!

About Chidem Kurdas 58 Articles

Chidem Kurdas is a financial journalist, analyst and writer.

Throughout her career she has held numerous positions, including: Research Analyst at Thomson Reuters, New York Bureau Chief at HedgeWorld, News Editor at Infovest21, Senior Associate Editor at Medical Economics Publications at The Thomson Corporation. She is currently Editor at Opalesque Futures Intelligence.

She holds a PhD in Economics from New School University.

Visit: Mutual Fund Smarts

1 Comment on Why We Need More Speculators

Leave a Reply

Your email address will not be published.


*

This site uses Akismet to reduce spam. Learn how your comment data is processed.