In most newspapers, you don’t need to wait long to read some journalist beating up on evil speculators for the “damage” they do and the claimed “uselessness” of their activities. Tim Worstall points out that speculators are actually essential to smooth operation of free markets:
What is it that the speculator in food manages to achieve? They move prices through time. At the moment, there’s a drought, and so we think there will be less corn available for consumption next year, so its price goes up.
What would we like to happen? Should prices stay stable? We would all carry on using the amount of corn that we originally thought we’d get. And we’d run out — there may even be a famine. People tend to die in famines.
So what we’d actually like to happen is for people to prepare by consuming a bit less corn this year.
Some of this should come from substitution: farmers will feed wheat to animals not corn. Consumers might move from grits to weetabix for breakfast. Perhaps the fools putting corn into cars will move over to sugar cane to make ethanol from.
We would also like a supply effect: those who are currently growing corn might add a bit more fertiliser, take more care in harvesting, make sure less gets spoiled or lost in transport.
Rising prices causes both of those pretty neatly. Put up the price and people will use less, while suppliers will make more. And what is it that the speculators on the futures markets have done in response to this report of drought? They have raised prices.
