Why We Need More Speculators

March 10, 2010

by Chidem Kurdas

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.

6 Responses to “Why We Need More Speculators”

  1. Mario Rizzo Says:

    An implication of what you are saying is that all of this talk of regulating (punishing?)the speculators may reduce the supply of speculators and increase the chance of collusion.

  2. Blah Says:

    Does the US accept responsibility for the War in Iraq, literally destroying millions of lives? Didn’t Bush deflect responsibility off his administration? Tell us something new…

    Maybe if the US wasn’t playing the same game on the Greeks all those years, not solving the Cyprus crisis and allowing Turkey to breath on them constantly by supplying them with more weapons, maybe Greece would’ve kept some of the $ and not blame this on speculators.

    Americans need to grow up, read/learn some history and then blame weaker countries. Everyone outside the US knows which is the most corruprted country when it comes to politics(Kennedy killed by conservatives/illuminatis, Bush senior announced the New World Order in 1991 in Iraq). Again tell us something new..most non Americans don’t believe the crap the US press writes lately on this blown out of proportion issue.

  3. chidemkurdas Says:

    Mario, if regulation significantly reduces the number of traders, then the danger of collusion will certainly rise. There may be regulatory changes that don’t reduce competition and one would have to look at specific rules to understand the impact. But heavier regulation typically does act as an entry barrier–for one thing, it increases the overhead cost.

  4. chidemkurdas Says:

    Blah– re “most non Americans don’t believe the crap the US press writes lately on this blown out of proportion issue.” Are you saying that the Greek debt payment issue is blown out of proportion? While I’m no expert on the Greek economy, one gets impression that there is a dire situation.


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  6. Robert Says:

    Excellent article, Chidem Kurdas. The perpetrators (government) will never admit to creating the problem, the victims (the citizens) are not intelligent enough to understand. What we conveniently have is a scapegoat (speculators) to make us all feel better yet solve nothing. US government forced banks to loan money to high risk individuals that were unable to pay back. Credit derivatives were created to hopefully decrease the risk. What else could they do? Choices were to take on high risk loans or face lawsuits and go bankrupt.


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