God must be idle these days as far as financial markets are concerned since there are so many people doing his work! Lloyd Blankfein, the CEO of Goldman Sachs, claimed recently that his firm is doing God’s work — it is incidental that Goldman has been sued by US regulators for cheating his clients. (Goldman Sachs itself earns 80 per cent of its profit from trading — a euphemism for speculation.) This reminds me of the title of an article by Paul Murphy (Financial Times, March 13), “The truth about speculators: they are doing God’s work”. Clearly, the French president and the German chancellor were not only foolish, but anti-Christ, when they called on the European Commission to ban naked short-selling of sovereign bonds and trading in credit default swaps which curb speculation!
To be sure, speculators do play a role in creating liquid markets. Other players like hedgers, arbitrageurs and long-term investors are not enough to create continuous market liquidity and prices. Also, speculators sometimes play an important role in “arbitraging” away the difference between current prices and true values by selling or shorting an over-priced asset, or buying an undervalued one. This, obviously, does not happen always. Indeed, more often than not, they become trend followers rather than value players. One basic law of economics is: higher price of an asset — a share, or a dollar in currency market, etc. — should reduce its demand. This law holds good if the transaction is between the producer and the consumer: a rise in price of onions will surely reduce the demand for the vegetable from a housewife.
But this is rarely true in the case of a speculator as he looks upon onions as an “asset class”, and is willing to buy them in the hope of a further increase in price. (In a more innocent age, such people were called hoarders). In their case, a price rise often increases demand, creating, for a time, a “virtuous” circle — higher price, higher demand, still higher price, still higher demand… virtuous of course for the speculator. The so-called “carry trade” is a good example of this. In any case, as Keynes said a long time ago, even otherwise it is better for one’s reputation to be wrong in the company of others than be a contrarian! Therefore, to quote him again, “We devote our intelligences to anticipating what average opinion expects the average opinion to be.” As for buying undervalued assets and selling overpriced ones to arbitrage the difference between price and value, and between different but similar assets within the same class, hedge funds were originally doing this. But, as Keynes said, “Markets can be ‘irrational’ for a lot longer than you can be solvent.” LTCM and Amaranth, the hedge funds, found this to their huge embarrassment. Therefore, such an activity requires a long time horizon and low leverage. It is more “investment” than it is “speculation”. The basic difference is to buy an asset for long-term returns, or for selling it at a higher price as soon as possible with no value addition.
I have two basic objections to considering speculation as “God’s work”. For one thing, unlike every other wealthy person who contributes to society by creating employment and producing goods and services, the speculator’s value to society is often negligible. Yes, sometimes their activities do correct asset prices, and they provide market liquidity which is presumably in the long-term interest of the economy. Too often, however, speculation is “rent seeking”. The other impact of speculative profits is to make society believe that “the path to riches lies in buying and selling pieces of paper rather than in making things” (Vir Sanghvi, Hindustan Times, May 16). As Keynes argued, “Speculators… may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation”. Surely, not in the long-term societal interest, let alone being God’s work!
Strikes in China
Is it a mere coincidence that a spate of strikes and hefty pay rises have been reported from China in the weeks preceding the G20 Summit? One doubts. In a way, this takes some pressure off China to raise the value of its currency — as does its rise against the euro in parallel with the dollar’s as cost rises push up the value of the currency in “real” terms. That the wage rises were/are needed is another matter. The share of wages in China’s GDP had not gone up despite very fast growth of the economy. The wage rises may also help increase domestic consumption and hence reduce current account surpluses. To be sure, the surplus as a percentage of GDP has halved over the last two years — during the global recession. But exports grew almost 50 per cent in May, and the politically sensitive US deficit has stopped falling and may well start growing again despite US exports to China recording 20 per cent growth. The softness in consumer spending in the US also has implications for growth and job creation; and creates political pressure to find somebody, preferably a foreigner, to blame! China is obviously a prime candidate.