Originally published September 7, 1981
IF YOU’VE GOT some money and want to use it to get more, there are three quite different things you can do: You can gamble, you can speculate, or you can invest. Since all three are ways of getting rich – or of going broke – your choice may not make much difference to you. But it will make an enormous difference to the economy, especially in a period of inflation. Perhaps because the choice is immaterial to the person with money, the effect on the economy is not generally noticed, with devastating consequences.
Speculation – what we’re mostly going to be concerned about here – has long had a bad name with the man in the street. Speculators, whether in Continental scrip or Civil War greenbacks, in city lots or rolling farm land, in domestic silver or imported coffee, have traditionally excited the envy or the hatred of their fellow citizens. In everyday speech speculation falls somewhere between gambling and investing; its connotations are disapproving. Although not quite so reprehensible as gambling, it is still suggestive of something secured for nothing, generally at an undue or unsafe or unsound or even unsocial risk. Brokers warn against speculative stocks, and the courts consider it imprudent to risk widows’ and orphans’ pittances on such issues. A successful speculator is a standing reproach to anyone who works for a living.
Most academics, however, disapprove of disapproving holding it to be unscientific, and possibly for this reason you can read many standard introductions to economics without ever encountering the word “speculation.” Hard-headed bankers and publicists ‘and – more to the point – hard-headed lawmakers tend to follow ‘the textbooks’ lead and ignore the activity. This neglect has helped to skew the economy and, in the present state of the world to frustrate many well intentioned measures to control inflation. For speculation is real enough, and there is reason to believe it is as much a cause as a result of inflation. To see why, we must distinguish among the three roads to riches. Our distinctions are not idle; they are of the utmost importance for the understanding and management of the economy-and, I am sorry to say, they are original.
Gambling is risking wealth in a zero-sum game. In any gamble-betting on cards or horses or football games- if some players win, some other players must lose the same amount. The winnings and the losings (after properly allocating taxes and the house’s cut) add up to zero. Nothing has been accomplished.
Speculation differs significantly from gambling in that it is not a zero-sum game. Speculation is risking wealth in an activity where all the players can win, or all can lose, or some can win and some can lose. It involves the buying and selling of stocks and other claims to wealth, the attempt to profit from or hedge against the vagaries of the market, the merging and spinning off of businesses, occasionally the churning of exchanges, the hoarding and dumping of almost anything imaginable. It creates no wealth but rearranges – sometimes to the very great profit of the re-arranger – wealth that already exists. It has been argued that, in the aggregate and over time, what goes up must come down and therefore speculation is a zero-sum game, too. But the speculative run is parallel, if not identical, with the inflationary run. If speculation were an irrelevant zero-sum game, inflation would likewise be nothing to fuss about: the two would rise and fall (assuming they do) together.
Investing is akin to speculation in that it is not a zero-sum game. In a healthy economy it is possible for all reasonably astute producers to profit, at least to-a degree, and contrary to current thinking this is true whether or not resources are limited. Investing differs from speculating in that it uses wealth to create new wealth. Its aim is the production and distribution of goods and services. These may be new kinds of goods and services, or they may be more of the same; they may be produced in new ways or in the good old ways; they may be provided by new businesses or by expansions of existing businesses; they may be what your heart desires or what you scorn as shoddy. The point is, economically they are goods.
Gambling, speculating and investing are frequently distinguished, notably by laymen and lawyers, on the basis of risk. Yet all three are risky. (To paraphrase President Kennedy, life is risky.) Nor is there any correlation between risk and economic effect. In gambling, the odds are often known with mathematical precision; that is ‘what makes casino owners rich. In speculating, one can command the services of brokers and advisers who spin out their lives poring over charts and tables. Investing, On the other hand, can be very risky indeed; despite meticulous market research, a highly promising new product may turn out to be an Edsel.
Economists, being locked into their equilibrium models; generally confuse the issues in another way. Gambling, it is obvious to them, has no impact on the economy, except to the problematic extent that it distracts people from more productive endeavors. What one wins, another loses, and the GNP remains as before. I n a world enjoying relative equilibrium, speculation seems no different. Commenting on John Maynard Keynes‘ ultimate disapproval of speculation (after he had made a small fortune buying and selling foreign currencies), Roy Harrod gives us the classical view: “As regards the gains of the successful speculator, in the case of foreign exchanges, this was solely at the expense of the unsuccessful, who, since he has voluntarily incurred the risk, had no legitimate hardship if the risk went wrong. In the case of commodities, the same argument largely applied: what speculator A gained, speculator B lost….”
That is a fair enough description of what happens-provided the-economy is in equilibrium. But suppose the economy is not in equilibrium, or even close to it. Suppose, indeed, that inflation is, as they say, raging: 4 per cent a year, 5, 8, double-digit, 12 per cent-with no end in sight. What does speculation look like now? Most important for our purposes, it no longer looks even vaguely like a zero-sum game. With a little bit of luck almost any of the speculators can win. There need be no losers among those who play the game. Some may, to be sure, gain more than others. I may sell my pot of gold just before it makes a great leap forward, but even the more sluggish hog-belly futures that I then buy are also on their way up.
IN SUCH a situation only the timid or foolish (or impoverished) will forgo the fun. The brash and clever and rich will, moreover, recognize that in inflationary times the thing to do is speculate: in common stocks of companies that (like Conoco) have substantial holdings of natural resources, in commodities, condominiums, works of art, objets d’art, collectibles. Almost anything can be a collectible. One of G. Gordon Liddy’s regrets was that he felt obliged to shred his match-folder collection lest it reveal to the Watergate investigators the many motels he had stayed at as he careened down the sub rosa way.
Keynes devoted 10 pages of The General Theory of Employment, Interest and Money to an attempt at differentiating between short-term speculation (which he saw as the pervading vice of Wall Street) and long-term “investment” by a “professional” who makes a point of understanding the businesses whose securities he buys and “who most promotes the public interest.” Yet except as one has a pseudo-esthetic preference for steadiness over flashiness, it is hard to see the differentiation. Even Keynes acknowledges that the lucky or clever speculator may make larger sums than his more careful cousin. And it does not matter to the companies whose securities are traded. After the first sale to the public, the buying and selling of their shares does them no good, and ordinarily no harm, either. Surely they don’t care how intelligent or stupid the buyers and sellers may be.
Corporation executives do of course take an intense interest in the vicissitudes of their companies’ stocks. Partly this is because they may own some, or have options that are worth more as the stock goes up; partly it is because their present salaries, and prospective salaries elsewhere, are dependent upon their success in making money for the speculative investors who play the market. In certain instances their companies may want to attract additional funds for some purpose or other-even including the expansion of production, although this is not very likely in inflationary times.
One of today’s common misapprehensions is that the securities and commodities exchanges are engaged in supplying capital to those who produce goods and offer services. No doubt the exchanges once did actually encourage the investment of funds that might otherwise have lain hidden in mattresses because of their owners’ liquidity preference. But that day is long past. The value of all new stock issues (many – if not most- of which had only speculative ends in view) on all exchanges in all of last year, was about the same as one week’s trading on the New York Stock Exchange alone.
It is safe to say that considerably less than 1 per cent of the transactions on the financial and commodities exchanges have anything whatever to do with productive investments. The rest are speculations. No producer gains the use of capital from them. Though the traders-may become rich, no new wealth is created by their frenzied activity. Yet because it became public policy (Icing before supply-side economics was thought of) to encourage investment, so-called long-term capital gains are taxed at a very favorable rate-just cut to
20 per cent. Given the tiny fraction of exchange transactions actually supporting production, it is plain that the favorable treatment almost exclusively stimulates speculation.
And speculation sucks money into itself like a firestorm. It always can use more. Vast sums are needed merely to keep transactions afloat for the few days it takes the brokers’ back rooms to complete them. These sums swell with speculation. In the first six months of this year, the New York Stock Exchange set a new record of 6.1 billion shares traded, thus requiring upwards of 10 times as much money to conduct its business as it did only a few years ago. Meanwhile, everything from a collection of beer cans to an example of Picasso’s blue period has been soaring in price as much as 100 percent a year, and the amount of money this ties up obviously has been increasing correspondingly
No productive enterprise can make money that fast. The after-tax earnings on equity of the Fortune 500 business runs around 10-15 percent, even in good years. Now that the interest rates they have to pay (or earn internally are well into the double-digit range, their record is poorer. (That’s why this inflation hasn’t sent the stock market through the roof, as everyone expected.) Smaller businesses – the kinds that arouse the same sentiments as mom’s apple pie – are on the whole having a much harder time. A man is a fool to work to produce something in the hope of earning 10-15 per cent when he can make many times that simply collecting Dresden china (should his fancy rake that turn).
The speculator, on the other hand, is perfectly happy borrowing every dollar he can lay his hands on at 15-20 per cent or more if he can thereby turn a profit of 20-30 percent. Aside from his apparent gain, he gets an enormous bonus from the income tax laws. The interest he pays on the money he borrows is deductible at the same rate as ordinary income, while his profits are taxed at the very much lower capital gains rate. Leverage like that can be very attractive.
Similar considerations underlie the activities of conglomerating corporations. In fact, they levy a greater toll on the money supply than all the individual speculators combined. DuPont is borrowing $4 billion to consummate its CONOCO deal (a speculation in coal more than in oil, but certainly not in enterprise). Bankers argue that Conoco’s happy stockholders will recirculate their windfall by making new” investments.” Yet whether they take out their profits in riotous living or use them to bid up other speculations, the economic effect will be inflationary.
Twelve other giant corporations – mostly oil companies with conglomeration in mind – have secured lines of credit totaling $42 billion. This may be the iceberg. or only its tip, for scores of smaller (but still large) corporations have un totaled lines of credit to finance takeovers, Whatever they add up to, they represent money withdrawn from the economy at least until taken down, and in any case not available for productive investment. There is seldom the slightest pretense that conglomeration will increase production; the goal is the fast buck, and many billions of dollars are being devoted to pursuing it.
The situation has been aggravated by the policy of the Federal Reserve Board under former chairman Arthur F. Burns and his successor, Paul Volcker, The Fed’s attempt to hold down inflation by controlling the money supply has further encouraged speculation at the expense of productive investment. With speculators and conglomerators snapping up the limited funds available irrespective of interest rates, producers cannot afford the financing they would invest in new products or services, or new ways of providing old ones. This is how the recently discovered productivity gap came about, and the easing of the capital gains tax will widen it for having enhanced the appeal of speculation.
Productive enterprise has been so systematically starved during the Burns- Volcker years that-especially with the addition of millions of women and blacks to the labor force-a great influx of money probably will be required to get the economy working again. This is, indeed, an insight that supply-siders share with fiscalists. But so long as nothing is done to curb speculation, the new money, whether from the Fed or from lower taxes, will flow into speculation or consumption and leave production as hungry as before.
THE THING about speculation, of course, is that sooner or later the kissing stops; and almost everyone gets caught with a long position in tulip bulb futures. The South Sea Bubble bursts; Wall Street lays an egg. When the bubble bursts, speculation feeds on itself going down, as it had fed on itself going up. Going up, everyone can win; going down, everyone can lose. Successful bears are very few, and their contribution to the common wealth is to make the disaster worse faster.
Is a disastrous outcome inevitable? In the light of the nostrums the Reagan Administration has had enacted into law, some sort of disaster can be predicted with confidence (if that is the right word). Because of the FDIC (horrors! – Federal regulation), there will be no run on the banks this time, and that will be a blessed distinction from the Great Depression. Because of the SEC (another regulative agency!), Wall Street pools are a thing of the past, and it’s harder to make a killing there (so fewer will be killed).
But the expectations of the innocent supply-siders will surely be dashed on the rock of speculation: The proceeds of the tax cuts will not go into productive investment; the money· supply will continue to resist management; interest rates will not fall; the surge of inflation wiII not abate this side of recession. If there are cynical supply-siders, and I rather think there may be some, they will be pleased with what they see:· The rich will be richer (at least comparatively), the big will be bigger, and the nation’s markets will be more firmly controlled by the kind of leaders who have made such recent successes of the automotive and steel industries. Amid all this, cruel unemployment will steadily spread.
The disease was first named by the British, who called it “stagflation.” A moderately reflective person might have expected that the experience of Great Britain (which doesn’t have the excuse of OPEC) would give pause to the noisy enthusiasts for low capital gains taxes and high interest rates. The British have been playing the game longer than we have-and their stagflation is worse than ours. But it seems (hat we are doomed to repeat their game plan.
It is a crying shame. The grief that will be caused is incalculable. And speculation could be easily inhibited. The Federal Reserve Board could forbid the granting of loans for purposes of trading on any securities or commodities exchange, or for purposes of merging or acquiring businesses, The Fed already sets limits to brokers’ margin accounts; at various times in the past it has forbidden them altogether; it could do so again tomorrow morning. Congress could readily tax capital gains as. ordinary income (owner-occupied dwellings might be treated differently, although I can imagine strong arguments against this). At the minimum Congress could, without being reproached for irrationality, define a long-term” capital gain as one on property held for IO years instead of one. Even five years (recognized by the money markets as the definition of “long-term” financing) would be a great step forward, particularly if coupled with modifications of the charitable deduction and elimination of other inflationary tax shelters.
The Fed and the Congress don’t do these things because they think the sole difference between speculation and productive investment is that the former involves more risk than the latter. But the true difference is, to repeat, that speculation has only financial gain in view, while productive investment uses wealth to produce more wealth. Though the risks may be great, investment can stimulate the production of goods and services. Regardless of risk, speculation can only stimulate inflation. Production improves the common wealth and the standard of living of the citizens; speculation simply redistributes what is otherwise created, and deflation destroys it.
It should be remarked that my proposals to deter speculation do not take sides – and do not need to take sides – in the fiscalist vs. monetarist controversy. There is very likely much truth on both sides, but there is assuredly no help possible from either side if speculation is not discouraged. While I am not a gambling man myself, I do not think there will be no more cakes and ale. It is not proposed to outlaw gambling or speculation. It is merely proposed that our government stop encouraging speculation. The Fed’s doctrinaire (false doctrine) refusal to consider the uses to which our money is put encourages speculation. The Congress’ espousal of a low capital gains tax encourages speculation. The new gift and inheritance tax encourages speculation. It would be easy enough for us to cease and desist from these encouragements.
As matters stand, one may read the Wall Street Journal or the financial pages of tile New York Times or any other metropolitan newspaper day after day and find very little news on some days none at all – concerning people producing something to sell to other people to satisfy their needs or wants. The shocking fact is that a great number of the best and best educated brains in the country are caught up in speculation of one kind or another, in devising new speculative schemes and new tax shelters. Our laws foster a sad misuse of this potential national resource. Getting and spending we lay waste our powers. President Coolidge was wrong: The business of America in the 1920’s was not business; it was speculation. It is speculation again today,
Finally, it may be objected that the proposed discouragement of speculation will not, of itself, control inflation. Certainly not. But unless speculation is deterred, inflation cannot possibly be controlled. Unless one is ready to run the printing presses flat out, the only way to get money into productive hands is to see that little or none of it falls into speculative hands. The first step toward achieving this is understanding what speculation is. Speculation is not risky productive investment. Nor-emphatically-is it economically neutral, like gambling. Far from it: Speculation is coterminous with inflation-and, as we are in grave danger of soon rediscovering, coterminous with deflation, too.
The New Leader