That financial markets sometimes go off on one has been noted for centuries now. Dutch Tulips, the South Sea Bubble, Dotcom and more recently Bitcoin have all shown that the lust for easy speculation profits can lead to, well, to financial excess at minimum. Those with an orderly cast of mind like to point out that all of this is waste. If instead the truly wise and clever people – after we’ve installed them in government or at least the bureaucracy – could apportion society’s assets very much better. You know, truly invest in the diversity advisers civilisation so badly needs.
The thing is, economists often disagree at this point. Sure, financial bubbles, they occur. Sure, there’s waste in them. But perhaps the very bubble itself is an either useful or necessary part of the process.
Necessary in that perhaps it needs a mania to get some new technology over the finish line. I tend to think it’s not going to happen with Tesla but it did with Railway Mania. Without speculators searching for easy money the network never would have been built out. Without Dotcom Amazon probably wouldn’t have got funded through the decade it was scratching a living.
It’s also possible that it’s just useful. For the overbuilding in the mania might then leave assets that are repurposed to get other technologies over that finish line into general use. Global Crossing lost a fortune – no, really billions – on building out fibre optic cabling to girdle the world. Which was, after the bankruptcy, bought up by the Googles and the like to carry all this web and video stuff. It’s arguably true that without the previous overinvestment we’d simply never have developed – or perhaps not for decades – such resource and bandwidth-hungry hogs.
Tim Worstall, “Cloud Rendering – The Latest Proof That Investment Bubbles Actually Work”, Continental Telegraph, 2019-03-17.
February 2, 2024
QotD: Financial bubbles
February 1, 2021
In the wake of l’affaire GameStop, frantic regulators call for more power to intervene in the market
“Regulatory capture” is the term for situations where the regulators and the regulated begin to get too close and the regulated industries or organizations begin to indirectly control the actions of the regulator for their own benefit. A topical example would be the sudden, agonized cries of politicians and market regulators for new powers to clamp down on disruptive players like the Redditors or other small investors who triggered the rise in GameStop share prices causing potentially ruinous financial losses for regulated hedge funds.
“GameStop” by JeepersMedia is licensed under CC BY 2.0
Although the story has garnered the attention of regulators and even the White House, the wrong takeaway is to suggest options for retail investors should be restricted more than they already are. Yet this is precisely what William Gavin, Secretary of the Commonwealth of Massachusetts, has called for. Gavin argued that there should be a 30-day trading suspension on GameStop to protect “small and unsophisticated investors.”
Gavin’s suggestion would have serious extended consequences. First, consider the knowledge problem that is involved in constructing such a restrictive regulation. When exactly would a rally become unacceptable? Despite years of decline, Kodak experienced a rally after its announcement that it would move into pharmaceuticals. Would this be permissible? If so, one could simply point to GameStop’s decision to appoint three new directors in an effort to turn the company around. If this is not enough, regulators must clearly state what identified the investments as unacceptable.
It is unclear if there is a perfect benchmark to distinguish rallies. But without such a measure, the suspension proposal would put every rally at risk of wrongful closure — potentially halting the growth of companies and industries, alike. Worse yet, the fear of missing out on a rising stock may push some investors to rush in with less information than they would otherwise acquire. Even if it is in a traditional rally, an uninformed decision could cause more harm than good.
Yet suppose the knowledge problem is solved and there is a perfect measure in place. Should other protections be put in place? One could make the case for a law against allowing “unsophisticated” gamblers from going to Las Vegas and losing money. And although this may seem like a leap, Gavin himself told Reuters, “This isn’t investing, this is gambling,” when he spoke of the GameStop rally.
The rally has attracted the world’s attention, but it does not require it. Rallies are a normal part of financial market activity. The only difference here is that it was Main Street that pulled one over on Wall Street.
January 30, 2021
“The only thing ‘dangerous’ about a gang of Reddit investors blowing up hedge funds is that some of us reading about it might die of laughter”
Matt Taibbi says “Suck it, Wall Street!”
Meme stolen from Ace of Spades H.Q.
The press conveyed panic and moral disgust. “I didn’t realize it was this cultlike,” said short-seller Andrew Left of Citron Research, without irony denouncing the campaign against firms like his as “just a get rich quick scheme.” Massachusetts Secretary of State Bill Galvin said the Redditor campaign had “no basis in reality,” while Dr. Michael Burry, the hedge funder whose bets against subprime mortgages were lionized in The Big Short, called the amateur squeeze “unnatural, insane, and dangerous.”
The episode prompted calls to regulate Reddit and, finally, halt action on the disputed stocks. As I write this, word has come out that platforms like Robinhood and TD Ameritrade are curbing trading in GameStop and several other companies, including Nokia and AMC Entertainment holdings.
Meaning: just like 2008, trading was shut down to save the hides of erstwhile high priests of “creative destruction.” Also just like 2008, there are calls for the government to investigate the people deemed responsible for unapproved market losses.
The acting head of the SEC said the agency was “monitoring” the situation, while the former head of its office of Internet enforcement, John Stark, said, “I can’t imagine there isn’t an open investigation and probably a formal order to find out who’s on these message boards.” Georgetown finance professor James Angel lamented, “it’s going to be hard for the SEC to find blatant manipulation,” but they “owe it to look.” The Washington Post elaborated:
To establish manipulation that runs afoul of securities laws, Angel said regulators would need to prove traders engaged in “an intentional act to push a price away from its fundamental value to seek a profit.” In market parlance, this is typically known as a pump-and-dump scheme …
Even Nancy Pelosi, when asked about “manipulation” and “what’s going on on Wall Street right now,” said “we’ll all be reviewing it,” as if it were the business of congress to worry about a bunch of day traders cashing in for once.
The only thing “dangerous” about a gang of Reddit investors blowing up hedge funds is that some of us reading about it might die of laughter. That bit about investigating this as a “pump and dump scheme” to push prices away from their “fundamental value” is particularly hilarious. What does the Washington Post think the entire stock market is, in the bailout age?
H/T to Larry Correia for the link.
January 28, 2021
GameStop in a very different kind of game
In the NP Platformed newsletter, Colby Cosh looks at the fascinating gyrations of GameStop’s share price in the grip of an unexpected group of players in the market:
“GameStop” by JeepersMedia is licensed under CC BY 2.0
GameStop has long been seen by institutional investors as following down the road of Blockbuster Video: it’s a bricks-and-mortar retailer whose main product is downloadable from your sofa. For that reason, it is heavily shorted by professional funds who normally eschew short-selling, which does have the risky feature of potentially infinite negative downside.
Enter Reddit, the website for special-interest user forums of all kinds. A Reddit “Wall Street bets” board uncovered evidence in regulatory filings that some hedge funds had legitimately dangerous large short positions representing bets against GameStop’s flaccid share price. A few hobby investors began to buy GameStop out of a sense of adventure and perhaps nostalgic loyalty. More importantly, they began to preach the gospel to others.
This is explicit “market manipulation,” but done in the open; it is surely as legal as any other conversation. GameStop’s price (NYSE symbol: GME) surged upward as word spread amongst day traders and other amateur investors. And as the random-looking rise in price got noticed, the whole scheme, itself rather reminiscent of a video game, went viral.
As of Jan. 12, GME was below $20, which is about where most analysts thought it belonged on merit, or lack thereof. The price as I type this particular sentence is $328.81. The backs of some funds with heavy short positions have been broken.
High finance seems somewhat terrified, as amateur investing websites — ones pioneered by the financial industry itself — begin to throw roadblocks in front of late-arriving GME buyers. For itself, Wall Street will invest billions replacing copper wire with fiber optics to gain microsecond arbitrage advantages in the market; for you and I, the good old portfolio can get conveniently 404ed for an afternoon.
This suggests that Wall Street may not have reckoned with the full possibilities of a world of proletarian shareholders. The stock market has proverbially been a playground of “animal spirits” since long before John Maynard Keynes used that phrase in 1936. What happens to an ecosystem when new animals show up? One can surely count on at least a minimum of chaos; maybe the surprise is that it took so long to take this game-like, combative form.
October 28, 2018
QotD: Revolutionary price controls and the plight of Washington’s army at Valley Forge
By the end of 1775, Congress had already increased the nation’s money supply by 50 percent in less than a year, and state paper issues had already begun in New England. The Congressional Continental bills followed what was to become a sequence all too familiar in the western world: runaway inflation. As paper money issues flooded the market, the dilution of the value of each dollar caused prices in terms of paper money to increase; since this included the prices of gold, silver, and foreign currencies, the value of the paper money declined in comparison to them. As usual, rather than acknowledge the inevitability of this sequence, the partisans of inflationary policies urged further accelerated paper issues to overcome the higher prices and searched for scapegoats to blame for the price rise and depreciation. The favorite scapegoats were merchants and speculators who persisted in doing the only thing they ever do on the market: they followed the push and pull of supply and demand. In another familiar attempt to deal with the problems of inflationary intervention, they outlawed the depreciation of paper, or the rise of prices.
[…]
State and local governments presumed to know what market prices of the various commodities should be, and laid down price regulations for them. Wage rates, transportation rates, and prices of domestic and imported goods were fixed by local authorities. Refusing to accept paper, accepting them for less than par, charging higher prices than allowed, were made criminal acts, and high penalties were set: they included fines, public exposure, confiscation of goods, tarring and feathering, and banishment from the locality. Merchants were prohibited from speculating, and thereby from bringing the needed scarce goods to the public. Enforcement was imposed by zealots in local and nearby committees, in a despotic version of the revolutionary tradition of government by local committees.
Price controls made matters far worse for everyone, especially the hapless Continental Army, since farmers were thereby doubly penalized: they were forced to sell supplies to the army at prices far below the market and they had to accept increasingly worthless Continentals in payment. Hence, they understandably sold their wares elsewhere; in many cases, they went “on strike” against the whole crazy-quilt system by retiring from the market altogether and raising only enough food to feed themselves and their own families. Others reverted to simple barter.
Murray N. Rothbard, Conceived In Liberty, Volume IV, 1979.
December 22, 2017
QotD: Economic lessons from Christmas toy shortages
Toy marketing on this elite level — Canada should be proud! — creates enraged parents. Hatchimals disappeared from stores altogether many weeks ago, and the high prices commanded in the resale market have created an industry of colorful social-media abuse. Hatchimal hoarders (who can now command C$120-$140 on eBay for one egg) are alleged to be greedy monsters, ruining Christmas for single moms — that is, by making the toy available at a premium at a time when toy stores and the makers of the product are no longer any help. (If the toy had never been invented, or were otherwise unavailable at any price, there would be no cause for complaint.)
What we have here is the familiar operation of a strong human superstition: the belief in an illusory “just price” for a product. It is the same superstition that makes some music and sports fans angry at scalpers. But it is exacerbated in the Christmas-shopping milieu by the innate predicament of the parent, always an emotional hostage to their offspring.
The complainers know perfectly well their kids will survive if they have to wait a couple of months for a Hatchimal. They know they could buy many equally good (and equally ephemeral) toys for half what they might pay a Hatchimal hoarder. They probably even know, if I can play the obtuse childless know-it-all for a second, that an authoritative, confident parent could explain the situation to a child, and make them live with the explanation.
Parents always want Christmas to be just so, but in the people who are castigating Hatchimal resellers, you can hear the hints of desperation, maybe even bad conscience. The problem, angry moms and dads, is not the hoarders. They just saw the real problem coming, and it is you.
Colby Cosh, “How the Hatchimals Christmas craze got me to own up to my irrational baseball complex”, National Post, 2016-12-16.
June 17, 2015
Speculation
Published on 8 Feb 2015
Speculation is often considered to be morally dubious. But, can speculation actually be useful to the market process? This video shows that speculation can actually smooth prices over time and increase welfare.
Speculators take resources from where they have low value and move them through time to where they have high value. We also take a look at speculation in the futures market — for instance, can orange juice future prices help predict Florida weather? Let’s find out.
June 12, 2015
QotD: Gresham’s Law
Gresham’s Law states that bad money drives out good money. This can happen in both inflationary and deflationary monetary environments. Basically, it must means that people will spend their “bad” currency first to get the maximal value out of it, and save the “good” money for the future because it will not depreciate as fast. That’s why you see socialist government inveighing against “hoarders”, “wreckers”, and “speculators” — the good money is biding its time and flushing out the bad money first.
For example, consider the US fifty-dollar gold coin. These coins are collected for their numismatic value and not their currency value. In fact, these coins are useless as actual currency. Why? The value of the gold and silver in the coins far outstrips the face value of the coin. Gresham’s Law would drive the coins out of circulation — either they would be melted down for bullion, hoarded, or traded as barter (not currency!) for objects of similar value.
Monty, “Inflation, Deflation, and Monetary Policy”, Ace of Spades HQ, 2014-07-11.
April 3, 2015
April 10, 2013
If there’s a “Bitcoin bubble”, it doesn’t predict long term success or failure for the currency
In Forbes, Tim Worstall explains that calling the current rise in Bitcoin value a bubble does not actually pass a judgement on whether Bitcoin will be a long term success:
And yes, I’m still of the opinion that Bitcoin is in a bubble. You know the walks like a duck, quacks like a duck idea? If it does those then it’s a duck. And the price changes that we’re seeing in Bitcoin make me and many other observers think that Bitcoin really is in a bubble. Indeed, there’s some nice work here showing that many of the Bitcoins in existence are being hoarded and that in itself is bubble behaviour.
However, do let me make one more thing clear: whether or not Bitcoin is in a bubble or not doesn’t mean that Bitcoin will succeed or not. They are entirely different questions, as different as is your wife Welsh or is your dog female? They really have no connection with each other at all.
Let us take the standard bubble example always used, the Dutch tulipmania. We could use others, the South Sea Bubble, the dot com boom, or we could even use an entirely different set of examples, say the introduction of the automobile. That last being when a new technology arrived without a speculative bubble around it.
The point of the first three, and let’s stick with tulips, is that there really was a quite obvious bubble in the prices of them. Most of the participants in the bubble (as with the other two) knew quite well that it was a bubble too. Prices were way out of line with any sort of “true value”. However, do note this very well: the tulip did indeed go on to become an important part of the Dutch economy. Indeed, it’s still there right now. Vast fields of tulips are grown there every year to supply cut flowers and bulbs for replanting that are shipped all over Europe. It’s actually become so important that other flowers, grown outside Europe, are still marketed through Holland as that’s where all the skill and infrastructure is.
October 4, 2012
Why EU politicians love the idea of a Financial Transaction Tax
Tim Worstall explains why politicians love the notion of an FTT, and why all the benefits claimed for imposing an FTT are not going to happen:
Large numbers of people have convinced themselves that a Financial Transactions Tax (FTT) would be a really very good idea indeed. It would make the banks pay for the problems they’ve caused, it would lower speculation and thus lower volatility, it would raise a lovely large amount of money that can be spent on good causes and anyway, there are a number of FTTs around and they’ve not caused any problems, have they?
Politically this is of course quite wonderful. Lots of money to pay for things and it’s the banks that have to cough up? We’ll get tens, no hundreds of billions and none of us will really have to pay any of it? Let’s tax the other guy usually does gain public support after all.
The thing is, all of the stated joys of this tax are in fact untrue. I’m rather involved in this as I prepared evidence for the House of Lords on the point (evidence which I’m glad to say heavily influenced their final report). Other submissions also pointed to posts on this very blog here at Forbes in support of various points. Finally, this formed the basis of my one and only peer reviewed paper to date. You might say that I’m more involved in this story than I am in most.
The thing is, those four things which campaigners for the FTT say are the good things about it all turn out to be untrue. Firstly and most obviously, banks are companies and companies never pay tax. It’s always some combination of customers, workers and shareholders who do: for only a real human being can bear the burden of a tax. As to speculation, more speculation lowers price volatility so reducing speculation will increase volatility, not reduce it. An FTT would crimp economic growth and thus would reduce total tax revenue, not increase it and finally, we do indeed have several FTTs currently and also know that they crimp economic growth and thus reduce total tax revenue.
All of these things have been explained by all of the serious people (plus me, who you can regard as serious or not as you wish) who have looked at the question. And yet governments continue to sign up for what they keep being told is a seriously bad idea. They’ve even been told this in terms simple enough for a politician to understand.
July 2, 2012
What value do speculators offer?
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.
February 11, 2011
How “those evil speculators” actually provide a very useful public service
Tim Worstall has a very good summary of Adam Smith’s explanation of the very useful public service provided by speculators:
Back to food: this is exactly the argument that Adam Smith put forward to explain the activities of a wheat merchant (Wealth of Nations, Book IV, Chapter V, start at para 40, here, for a decent dose of 18th century prose). When wheat is plentiful (although he calls it corn — the English did not call maize corn until some time later), say after a harvest, the merchant buys it up and stores it. He then waits until prices have risen before he sells it. If his expected shortage in the future doesn’t arrive then he’s shit out of luck and loses money. If it does, then the happy populace now have wheat to eat. For, and here’s the crucial point: what our merchant, our speculator, has done is move prices through time.
If we all ate wheat like it was that bounteous time just after harvest all the time then we would run out of wheat entirely before the next harvest. Prices would, at that point, become really rather high. However, by buying in the time of plenty, he’s raised prices in that time of plenty: thus making everyone consume a little less in that Harvest Festival gluttony. He’s also lowered prices in the Hungry Time (in medieval times, the six weeks before the harvest was indeed known as this, it was the worst time of year for food supplies) because he has at least some grain available rather than none.
So we’ve reduced price volatility, stretched the available supply over more time, possibly even stopped some starvation, by someone being enough of a bastard to speculate on food prices.
Now note, this is physical speculation, actual purchase, taking delivery and storage.
Derivatives speculation, using futures and options, has less effect on prices. It gives us information about what people think prices might be in the future, for sure, but it will only affect today’s prices if high future prices lead to that actual physical storage and hoarding. Which could happen, to be sure, but won’t necessarily.
All of this leads us to what people like M Sarkozy are trying to say and what the WDM are screaming about. The latter, in their report linked above, come right out and say that as more people are playing with food derivatives, this is what has been pushing up food prices. This is nonsensical, in the absence of any physical hoarding. For a start, WDM seems not to realise than a futures market is zero sum: for any profit made by someone then someone else must have made an equal and opposite loss. For everyone going long (betting on a price rise) someone else must have made an equal and opposite bet going short (betting that prices will fall). That’s just how these markets are. It really doesn’t matter to spot (current) prices whether three people are betting £50 or 30,000 are betting $50bn: there will be an equal and opposite number of people long as there are short, by definition.
So it absolutely cannot be that “more people speculating increases food prices”.
WDM’s second point is that more speculation means more volatility in prices: something that almost all economists would regard with a very jaundiced eye. For the general assumption is that futures act upon prices as does Smith’s wheat merchant: they reduce price volatility. Fortunately, the WDM, in its own report, provide us with an example of this. In the 2006/8 price rises, it notes that there’s a deep and liquid speculative market for wheat and corn (maize), while there’s only a very thin one for rice. And yet it was rice that was vastly more volatile in price in this period: despite the fact that it was wheat and maize which people were turning into ethanol for cars (the true cause of the price rises) rather than rice.
The price of a good is also a signal of availability: the more scarce the item is, the higher the price will go. The higher the price goes, the greater the incentive to either limit the use of the item or to search for substitute goods. This is a key feature of free markets: without the price change signalling, consumers cannot accurately guage whether to increase or decrease their use of a particular good. This is why the worst possible reaction to a sudden price increase is price controls: remember the first oil crisis in the 1970s? Price controls meant that people could still buy gasoline at the “old” price . . . until there wasn’t enough to go around. Controlling the price creates artificial shortages and fails to rationally indicate to consumers to conserve or limit their consumption.
