In Defense of the speculators

 

In Defense of the speculators 

(originally posted on Intelligencequarterly.com)

“But the Mirror will also show things unbidden, and those are often stranger and more profitable than things which we wish to behold. What you will see, if you leave the Mirror free to work, I cannot tell.” (“The Lord of the Rings”, J.R.R Tolkien)

Given the sad state of the Economy in Europe, especially Energy, the Italian media and the election campaign is rife with calls by politicians and punters to “punish speculators”, and our government went as far as to impose an extraordinary tax on “extraordinary profits” of energy companies, on top of Premier Draghi proposal to the EU to agree to a price cap on gas bought from abroad.

Yet, lest some quick witted person undertakes to try, “Speculation” is not a sure thing, and unless some background is provided to the obvious framing going on, the term is much maligned and utterly misunderstood.

So, without further ado, let's delve into what is one of the earliest recorded SUCCESSFUL speculation, which allowed humanity incredible progress. Those unfamiliar with pre Socratic philosophers might not know Thales of Miletus (624 – c. 545 BC), the father of Science according to those that came after him. According to sources, Thales , predicting UNDER UNCERTAINTY a bountiful harvest of Olives for the following season, either bought the olive presses (which in a sense makes it the first recorded “future” transaction) or reserved time on the presses, becoming rich in the process. That, Ladies and Gentlemen, was “speculation”: spending money/ resources on a conviction involving the assumption of a risk. SUCCESSFUL speculation, as in the case of Thales, is the payoff, NOT the speculation. Yet to the best of my knowledge, no government ever decried the fact that speculators lost money on unsuccessful ventures. Like the current Italian administration, government wait until someone earns money on that and THEN start the media campaign to retrieve what they perceive as their rightful “pound of flesh”.

Of course, that's nonsense, because the essence of speculation lies in a division well described by Nassim Taleb in his works: you can either be a “seller of lottery tickets”, i.e. structure a long series of small winning bets in return for a disproportionate one off loss, or be a BUYER of lottery tickets, which means losing small most of the time in return for a big infrequent payoff; Human nature draws people to the first profile. Not only that: ALL “agents”, i.e. those who are NOT actually risk bearers but have a finger in the pie, have a much bigger commercial / consensus success if they strictly engage only in the “frequent small win” game, and on different casino tables if at all possible. Think “Big a** asset managers”: their “our fund X has beaten his benchmark for Y years in a row!”, coupled with size problems relative to actual investable markets leading them to slice their offering in literally thousands of different funds, means that they only gather assets if they do that. At their size level, they simply get steamrolled by any and all systemic crisis, like an elephant trying to get out of a mouse trap door.

But which other player type has a vested interest in the false predictability of the lottery ticket seller, I wonder?

That's right. Governments, and their ilk, to the point that in Italy firms and self employed pay income taxes on PRESUMED income for the FOLLOWING year. Of course, in a system populated with many unpredictable businesses that wouldn't work, and there is another interesting consequence, which perhaps helps to explain the chronic growth gap of Italy in relation to other countries: when you win you have a cash outlay (tax), when you do not, you are still paying on assumed income (which might not be there in risky ventures), and above all what you get is not cash but a tax loss carry forward which our estimable lords do NOT allow to exchange/monetize between different firms.

But, going back to Speculation: speculators LOSE most of the time, or engage in time limited ventures in which price, being the medium of the free systems to signal scarcity, attracts one off conversion of resources by also paying the cost of reconversion to the previous activity.

Let me provide you with an example: masks at the start of COVID. At the time, masks, especially FFP2 ones, were scarce. The papers were FILLED with outraged articles saying “It's a scandal that something that costs 30 cents to produce should be sold at 10 Euros !”. Well, maybe ten years of QE have taken away Einstein's tenet that the time arrow can only go forward, because there is a definite difference between “ an FFP2 mask today, in the pharmacy around the corner”, and “a million FFP2 neatly packed in standard containers, delivery in six months, Shanghai port”.

The price of ten Euros is the way reality tells you “Quit whatever you are doing and produce masks here”, precisely as the current Energy prices in Europe are telling “quit dillydallying and get whatever reliable 24/7 energy you can put on line NOW!”. In the case of masks, here in Italy the “profiteers” were immediately stopped, despised and loathed.

The trouble here is that prices are telling an unpalatable message to people who made a career out of preaching the exact opposite of what cruel reality is telling them. You don't ask a problem to help solve a problem, see Germany and their stance on the six workable nuclear plants. And as De Tocqueville predicted, once politicians understand that they can buy consensus from citizens by spending the citizens' money, all hell breaks loose. Recent proposed measures are a case in point. Practically all of them simply shift the Supply problem either by using the “rose by any other name” routine, or by shifting the problem down the road (which by the way is how Italy got to 150% debt /GDP).

The “rose by any other name” trick is quite wily. Suppose you say, in a system where you do not assume additional debt by allowing government spending to run wild, that you tell families “The government will allocate 15 billion EUR to keep electricity prices for families within bounds”. Now, taken in their aggregate, what happens is that those same families will STILL pay those 15 bn. EUR more than the year before, but it will be disguised in unrecognizable ways, like “sovrapprezzo termico”, increased income taxes, or, as it happens, a combination leading to the ultimate fudge: Inflation. Everyone gets poorer (and mind you, the poorer get poorer than the others), Government debt falls in real terms, and barring a credit event the lure for politicians is too great to pass up.

In a working system, the price of money would also rise and punish the government by increasing the transfer back to the owners and RISK BEARERS of capital, but Mario Draghi's ECB saw to that, we even had negative rates for crying out loud, and the gap between inflation and rates has never been greater since I got my driving licence at 18 years of age.

So, in a world like the energy space where the small fry cannot “speculate”, that “warehousing” quality of speculation accrues to energy Companies, who ordinarily would invest in order to satisfy demand were it not that the political masters don't want them to.

Also, going back to another, unsung consequence of successful speculation: the year AFTER Thales got rich on olive oil processing, would you expect the number of olive presses in Miletus to be bigger, equal or smaller?

That's right. BIGGER is the right answer. Speculative fever brings glut, which ironically is like the human fever in that it's the time a person who is ill feels worse, but then leaves behind people who remember that at one time Thales got rich, who stow away the tools to assemble olive presses... the speculators of tomorrow are the economy's antibodies to successive crisis, teaching the body to remain on alert and making it worth for a despised part of humanity to keep resources immobilized to profit from eventualities. So, attacking speculators as a race is like saying ti would be wise to do without antibodies altogether. Congratulation, all concerned !!