Welcome back to the Deep Dive. Today, we are
putting a very specific word under the microscope.
A very loaded word. A very loaded word, yeah.
Yeah. It's a word that, if I'm being honest,
usually comes with a bit of a sneer attached
to it. It conjures up these images of, you know,
shouting men in polyester suits on trading floors,
bursting bubbles, maybe a villain in an Oliver
Stone movie. Or that guy at the party. We all
know that guy. Oh, that guy. Yeah. The guy who
won't stop talking about crypto. Exactly. Exactly.
We are talking about speculation. It certainly
carries a tremendous amount of cultural baggage.
It does. And usually when you hear someone called
a speculator, it's not a compliment. It implies
recklessness. It implies, you know, gambling,
greed, profiting off something without actually.
building anything. But we've pulled together
a stack of sources today. We've gone through
the Wikipedia entry on speculation, historical
accounts of market manias from way back in the
1600s and some really heavy hitting economic
theories from the likes of Keynes and Graham.
Right. And they all suggest that the reality
is. Well, it's a lot more complicated. It is.
The central tension we're going to explore today
is really a question about the architecture of
our world. Oh, so? Well, are speculators just
reckless gamblers who cause financial crises
and chaos? Are they actually the unsung essential
heroes who keep the global economy from freezing
up? OK, that is a massive claim. Heroes, really.
It's the argument. Because my visceral reaction,
and I think most people's, is no way. You know,
you think of the 2008 crash, you think of gas
prices spiking. Yeah. You blame the speculators.
And that's the reputation, often for good reason.
But we're going to try and look at the mechanics
beneath the market movements. We're going to
talk about tulips. We're going to talk about
onions. Oh, yeah. Onions play a surprisingly
large role. American Legal History, and we're
going to talk about human psychology. I am still
stuck on the onions, but okay, I'm sure we'll
get there. So our mission today is to move beyond
that pejorative definition and really unpack
the machinery of risk, price, and value. Let's
do it. So let's start with the basics. If we
strip away all the emotion, all the baggage,
what actually is speculation? Well, if we look
at the standard definition, you know, the one
used in finance and how our sources break it
down, it's the purchase of an asset. An asset.
So that could be anything. Anything. Like wheat,
goods, real estate, stocks, you name it. But
it's the purchase with the hope. The hope, not
the certainty. Exactly. The hope that it will
become more valuable in a brief amount of time.
Okay. So hope and brief. Those seem like the
two key words there. They're everything. And
the most important distinction here is that the
speculator is focusing purely on price movements.
They aren't necessarily interested in the fundamental
value. You mean like if a company actually makes
a good product. Right. Or the utility of the
thing they're buying. They don't really want
to own it. Not in the traditional sense. They
want to sort of. Rent the price movement. Rent
the price movement. I like that. So let's use
a classic analogy to make this concrete. Buying
a house. Sure. Perfect example. If I buy a house
because I want to live in it, raise a family,
maybe plant a garden, that's utility. Yes. That's
consumption or a very long -term investment.
You care if the roof leaks. You care about the
school district. Right. I'm buying the houseness
of the house. Correct. You're consuming the asset.
If you buy a house in a neighborhood because
you read some blog post saying it's the next
big thing. And your plan is to just paint the
front door red and flip it in six months for
a 20 percent profit without ever moving in. That
is speculation. You don't care about the roof
or the schools. Not really. You care about the
price trajectory. You're betting on the belief
of the next buyer. Got it. OK, that makes sense.
But the market isn't just made up of speculators
and. you know homeowners our sources break down
the financial markets into four primary characters
and i found this really helpful to visualize
the ecosystem it's like a cast of characters
in a play it is and this is crucial for understanding
why the speculator exists you can't understand
the speculator without understanding who they're
trading with okay so who's character number one
the first character is the hedger the hedger
this sounds like the cautious one The responsible
one. They are the pragmatists. The hedger is
someone who transacts to offset a pre -existing
risk. A pre -existing risk. What does that mean?
The classic example is a farmer. Let's say you
grow corn. Your entire financial life is terrifying.
Right. Because you have all the costs up front.
The seeds, the fertilizer, the diesel for the
tractor. Yeah. But you have no idea what the
price will be when you actually have the product
to sell months later. Exactly. You plant in April.
You harvest in October. What if the price of
corn crashes in September? You go bankrupt. You
lose the farm. That is a massive, massive risk.
So what does the farmer do? How do they hedge?
So a hedger, the farmer in this case, might go
into the market and sell a contract to deliver
that corn at a fixed price later in the year.
So they lock in their price today. They lock
it in. They are hedging their bet. Now, they
give up the chance of a massive windfall if corn
prices were to suddenly skyrocket to $10 a bushel.
But they're safe. They're safe. They've protected
themselves against a crash down to $2. They are
buying certainty in an uncertain world. Okay,
so hedger equals safety first. They're using
the market to remove risk from their life. Who's
character number two? Number two is the arbitrage.
The arbitrage. I always feel like I need a monocle
and a top hat to say that word. It sounds incredibly
fancy, but the concept is actually very simple,
very mechanical. OK. The arbitrage just seeks
to profit from price differences for the exact
same item in different markets. It's all about
spotting inefficiency. So like. An example. Let's
say gold is trading for $2 ,000 an ounce in London.
And for some weird glitchy reason, it's trading
for $2 ,005 in New York. So the same exact bar
of gold has two different price tags depending
on where you're standing. For a brief moment,
yes. The arbitrage sees this instantly. Their
computers see it. They buy it in London for $2
,000 and instantly sell it in New York for $2
,005. Then they pocket the $5. That feels like
free money. Is it really that simple? It's essentially
risk -free profit, yes, but it requires incredible
speed and technology. And here's the social value
of what they do. There's a social value. Absolutely.
By doing that trade, they actually help equalize
the prices. Their buying pushes the London price
up a tiny bit, and their selling pushes the New
York price down a tiny bit until that $5 gap
closes. So they're like the market's referees.
They keep the global market in sync. They enforce
logic. That's a great way to put it. Yes. Got
it. Okay. So hedgers and arbitragers, number
three. Number three is the investor. This is
the one we're probably most familiar with. The
long gamer. The Warren Buffett type. Exactly.
The investor seeks profit through the long term
ownership of the instrument's underlying attributes.
So this is the person buying a stock because
they believe the company makes good cars or it's
well managed or pays a good dividend. Precisely.
They are looking at growth, earnings, yield.
They plan to hold it for years, maybe decades.
They treat the stock like they're owning a tiny
piece of a business, not like a lottery ticket.
And finally. That brings us to character number
four, the star of our show today. The speculator.
The speculator. So how do they fit in with these
other three? Well, they're defined by what they're
not. They don't have a crop to hedge. They aren't
farmers. OK. They aren't looking for those tiny
microsecond price gaps like the arbitrage. Right.
And they aren't necessarily married to the long
term success of the company like the investor.
They trade purely to anticipate price movements.
They are taking on risk voluntarily. Voluntarily.
That's a key word. It is. They're taking on risk
in exchange for potential profit. So if we look
at the flow of energy here, the hedger, the farmer.
is desperately trying to get rid of risk. The
speculator is voluntarily walking in and taking
it. That is the symbiotic relationship right
there. And this is the core of the argument for
why speculation is necessary. You cannot have
a hedger who wants to sell their risk. Unless
you have a speculator on the other side willing
to buy it. We are definitely going to drill deep
in that mechanism later because that sounds like
the heart of the hero argument. It is. But before
we get there, I want to touch on something our
sources mentioned about the fuzzy line. Because
hearing those four definitions, it all sounds
very neat and clean. But in reality, isn't the
difference between an investor and a speculator
a little subjective? It is notoriously fuzzy.
It's often a matter of time scale and self -perception.
Even Benjamin Graham. The father of value investing.
Warren Buffett's mentor. That's the one. He wrote
about this in his famous book, The Intelligent
Investor. The Bible of investing. Yeah. What
was his take on it? Well, he struggled with it.
He tried to draw a line. He defined the defensive
investor as someone interested chiefly in safety
and, quote, freedom from bother. Freedom from
bother. I like that. But even he admitted that
some speculation is. basically unavoidable. He
said, essentially, that risk has to live somewhere.
It must be assumed by someone. Right. If you
buy a stock, even if you plan to hold it for
10 years, there's no guarantee it goes up. I
mean, huge companies have gone bankrupt. Kodak,
General Motors. You're speculating on the future
to some degree anytime you buy anything. Exactly.
Graham pointed out that even long term buy and
hold strategies can be classified as speculation
unless your primary motivation is just income
like from dividends or the safety of your principal.
If you are secretly hoping the price doubles.
Which everyone is. Which everyone is. Then there's
a speculative element to what you're doing. It's
a spectrum not a binary switch. And the regulatory
body is like the CFTC. That's the Commodity Futures
Trading Commission in the US. Correct. They have
to have a stricter definition right. They can't
just go by vibe. They can't look at a trader
and say, hmm, he looks like he's hoping a little
too much today. No, you can't regulate vibes.
The CFTC keeps it very, very simple. For them,
a speculator is a trader who does not hedge.
We'll stop. Full stop. If you aren't a farmer
protecting your crop or an airline protecting
its future fuel costs. You are a speculator.
It doesn't matter if you're a grandma buying
one share of AT &T or a massive hedge fund buying
a billion dollars of oil contracts. If you don't
have a direct commercial interest in the physical
underlying asset, you are, by definition, speculating.
Simple as that. OK, so we know what they are.
Now let's talk about where they came from, because
this isn't a modern invention. This isn't some
crypto bro thing. People have been betting on
prices since. Yeah. Well, since we add prices.
For centuries. The sources really highlight the
17th century in the Netherlands as a major turning
point. The Dutch. This is really where commodity
markets as we know them were born. The Dutch
were the absolute masters of trade. They invented
the stock market, the central bank, and arguably
the speculative bubble. And you cannot talk about
17th century Dutch markets without talking about
flowers. Tulip mania. 1634 to 1637. This story
never gets old. It's like the original sin of
finance. It is the archetype. It's the story
everyone tells to warn about speculation. What's
so fascinating is the mechanism behind it. The
Dutch Calvinist society at the time had strictly
banned gambling. Okay, so no casinos. No casinos,
no betting on dice, so people needed an outlet
for that risk -taking impulse. Yeah. And they
turned to tulip bulbs. Which seems so. Wholesome.
Flowers. Until you realize people were trading
their houses and their life savings for a single
root. For a single bulb. And specifically the
most valuable ones were the broken bulbs. The
ones with these beautiful fiery stripes, which
we now know was actually caused by a virus infecting
the bulb. So they were paying a premium for a
sick flower. They were. But here's the technical
innovation that really matters for our story.
They were trading forward deals. Most of this
frantic trading happened in the winter. And why
does the season matter so much? Because in the
winter, the bulbs are in the ground. They're
dormant. You can't physically hand over the tulips.
It doesn't exist yet, in a way. So what were
they trading? They were trading pieces of paper,
promises, contracts to deliver a specific tulip
bulb in the spring. This was arguably the first
widespread popular futures market. So they were
speculating on the future price of a flower that
was currently buried in the frozen mud. Exactly.
The Dutch had a fantastic name for it. The wind
handle. The wind trade. Literally, the wind trade,
because they were trading nothing but air and
the turnover was incredibly rapid. The sources
say in places like Harlem and Amsterdam, people
would meet in taverns. Not on some fancy exchange
floor. No, in a pub. And these paper contracts
would change hands 10 times a day. So I buy the
paper from you for 100 guilders. I turn around
and sell it to the guy at the next table for
110. He sells it to his friend for 120. And the
actual bulb hasn't moved an inch from under the
snow. Precisely. And we all know how that story
ended. In February 1637, the music stopped. Someone
tried to sell, and for the first time, no one
wanted to buy. Prices collapsed 90%, 95 % in
a matter of days. A spectacular crash. But it
didn't stop there. That wasn't the last bubble.
The 18th century saw even bigger disasters, right?
Oh, yes. The 1720s were a particularly bad decade
for Europe. You had the South Sea bubble in England
and the Mississippi Company in France, and they
both collapsed at almost the exact same time
around 1720. Now, these were massive corporate
disasters, right? These weren't just flowers
in a tavern. These were huge companies backed
by the government. They were enormous. The South
Sea Company was supposed to hold the monopoly
on all trade with South America. Everyone invested,
from the general public to the highest levels
of government, even Sir Isaac Newton. Isaac Newton,
the smartest man alive, the guy who invented
calculus and figured out gravity. He lost a fortune,
a life -changing amount of money. He famously
said, I can calculate the motion of heavenly
bodies, but not the madness of people. And these
events, the South Sea and Mississippi collapses,
were so devastating that they brought the entire
concept of speculation into disrepute in Europe
for generations. It became a dirty word. It was
seen as a moral failing, not just a financial
one. But it didn't disappear. It just evolved.
And our sources point to a specific year, 1867,
as a major technological shift. A moment that
changed speculation from a sort of tavern activity
into a global obsession. What happened in 1867?
The invention of the stock ticker machine in
New York. Ah, the ticker tape. That little chattering
strip of paper you see in old movies. It seems
so quaint now, doesn't it? But this was the Internet
of its day. It was a revolution. How so? What
did it change? Well, before the ticker, if you
wanted to know the price of a stock or if you
wanted to trade, you generally had to be. physically
present at the exchange. Or you had to have a
messenger boy running back and forth. So information
traveled at the speed of a running child. Exactly.
It was slow. It was exclusive. It was an insider's
game. The ticker changed all of that. It democratized
it. It democratized speculation. Suddenly you
could be in a broker's office miles away or eventually
in other cities and see the price almost in real
time. It made the market a spectator sport for
the entire country. It removed the need to be
on the floor. And I assume this just exploded
the number of people who were doing it. Significantly.
The sources give us a truly staggering data point
on this. In the year 1900, there were about 4
.4 million shareholders in the United States.
By 1932, just over 30 years later, that number
had jumped to 26 million. Wow. From 4 to 26 million.
So the ticker tape turned the market from an
exclusive club into a national obsession. Precisely.
And that brings us right back to the core conflict.
As speculation grew, as it moved from the tavern
to the living room, so did this huge debate.
Is this good or is this bad for society? OK,
let's play defense attorney first. Let's look
at the argument for the speculator as hero. This
sounds incredibly provocative, especially after
talking about the wind trade and Isaac Newton
losing his shirt. It is a view championed by
economists like Nicholas Kaldor and the famous
trader Victor Niederhofer. Their core argument
is deeply counterintuitive. Which is? They claim
that speculators actually stabilize prices rather
than disrupt them. OK, you have to walk me through
that, because when I think speculator, I think
volatility. I think prices. jumping up and down
like crazy because of rumors and panic. How on
earth do they stabilize things? They do it through
something called the sustainable consumption
theory. Let's look at two scenarios to explain
it. Scenario A, a shortage. Okay, let's say the
wheat harvest is terrible this year. There's
a drought in the Midwest. There's not enough
wheat to go around for everyone. Right. Now,
a speculator who studies this stuff for a living
looks at the weather reports, sees the satellite
data and realizes the harvest is going to be
bad before the general public knows. So what
do they do? They buy. They start buying wheat
now, betting the price will be higher later.
Exactly. Which drives the price up immediately.
Right. And people get angry. They say, look at
those greedy speculators in Chicago making bread
more expensive for my family. Yes, that's the
immediate reaction. But ask yourself, what happens
when the price of bread goes up? Well, basic
economics. People buy less of it. They conserve.
You know, maybe a bakery bakes slightly smaller
loaves, or families don't throw away the crusts.
You make it last. You make it last. High prices
force conservation. So that limited supply of
wheat is consumed more slowly. It gets stretched
out over the year. If the price had stayed artificially
low because there were no speculators forcing
it up early, people would have eaten through
the supply at a normal rate. And suddenly in
the middle of winter, there'd be zero wheat left.
That's a famine. So the speculator. By raising
the price early, it essentially forces society
to ration the scarce supply so it doesn't run
out completely. Correct. And there's a second
effect. That high price sends a massive signal
to other producers all over the world, like a
bat signal. A bat signal for wheat. It says,
hey, wheat is really expensive. Grow more. Or
if you're in Argentina and have a surplus, import
it to the U .S. It encourages new supply to come
into the market to meet the demand. That is actually
a really compelling argument. It's like the aha
moment. The high prices we hate during a shortage
are actually a survival mechanism. That's the
theory. Now let's look at scenario B really quickly.
A surplus. Let's say the harvest is massive.
The silos are overflowing. The price is too high
compared to this new reality. So the speculator
sees this and bets the price will go down. They
sell. They sell, which pushes the price down.
And what do low prices do? They encourage people
to buy more, to consume more, to export more.
It helps clear the surplus so it doesn't all
rot in the fields. So in this view, the speculator
is just a really aggressive. really fast mechanism
for finding the right price faster than anyone
else. That is the argument. They process information
weather, politics, shipping data, and they translate
it into price. This is called price discovery.
Without them, the price might be wrong for months,
leading to huge misallocations of resources.
Let's talk about another benefit the defense
brings up. Liquidity. The outline mentions the
pork belly example. I love that we're jumping
from tulips and wheat to bacon. This is a classic,
simple way to explain liquidity. Imagine a market
for pork bellies, which is, you know, bacon,
where the only participants are farmers who raise
the pigs and butchers who sell the bacon. Okay.
No speculators allowed. Just the makers and the
users. Yeah. Your utility. What's wrong with
that? The problem is timing. The farmer wants
to sell when the pigs are ready, let's say on
a Tuesday at 10 a .m. But the butcher wants to
buy when his inventory is running low, which
might be on a Thursday at 2 p .m. Their needs
don't line up. They don't line up. And even if
they happen to meet at the same time, the farmer
might want to sell for $5 a pound, and the butcher
only wants to pay $3. And since there's nobody
else around? No deal. Exactly. Because there
are so few of them, the gap between what the
farmer wants to sell for and what the butcher
wants to pay, that's called the bid -ask spread,
it might be huge. Without speculators, the market
is illiquid. It's hard to do a deal. You might
be stuck with your pigs. So end of the speculator.
The speculator fills that gap. They provide a
constant presence in the market. They are willing
to buy from the farmer on Tuesday at 10 a .m.,
hold the risk for two days, and sell to the butcher
on Thursday. They provide capital. They narrow
that spread. They ensure that if you want to
sell, there's always someone there to buy instantly.
And if you want to buy, there's someone there
to sell. That is liquidity. So they're the grease
in the gears. They make sure the whole machine
doesn't just grind to a halt. That's a perfect
way to describe it. A liquid market is a safer,
more efficient market for everyone else who uses
it. And then there's the risk bearing aspect.
We touched on this with the farmer earlier, but
I want to make sure we really nail this down
because this is arguably their most important
social function. It absolutely is. Let's go back
to the farmer and the corn scenario. Let's really
look at the psychology of that farmer. He is
terrified. He has loans to pay for his tractor,
for his land. If the price of corn drops to $2
a bushel, he loses everything. So in the face
of that risk, he might just choose not to plant
at all. He might say, it's too risky this year.
I'll just leave the field empty. Which is bad
for everyone because, you know, we all like to
eat. Exactly. Society needs the corn. So a speculator
steps in, maybe a guy in Chicago who has never
seen a corn stalk in his life, and he says to
the farmer, I will sign a contract today to buy
all of your corn in October for $4 a bushel.
Now, the speculator is taking a massive gamble.
If the price of corn drops to $2 by October,
the speculator has to buy it for $4. And loses
a ton of money. Yes. The speculator takes a blow
to the face. But the farmer. The farmer is safe.
The farmer is safe. He is hedged. He can go to
the bank, show them the contract, get a loan
for his seeds. He plants the corn. Production
increases. The speculator effectively acts as
an insurance company for the producer. When you
put it that way, it does sound heroic. I mean,
someone has to hold a hot potato of risk. And
the speculator is the one who says, throw it
to me. Throw it to me. I think I can handle it.
Now, sometimes they can't and they go bust. But
the key is that the farmer, the producer, survives.
Okay. There's one more argument for the defense,
and it's a controversial one. It involves shorting.
Ah, yes. Shorting. Betting against a company.
Betting the price will go down. This is usually
seen as the ultimate villain move. People say,
you want American business to fail. It's often
vilified, yeah. But you're saying there's a social
good here. A huge one. Hedge funds that specialize
in shorting can act as the canary in the coal
mine for the entire economy. How so? Because
they have a direct financial incentive to find
the rot. Think about it. Everyone else, the company
CEO, the investment bankers selling the stock,
the traditional investors who own it, everyone
is incentivized to be optimistic. It's an echo
chamber of positivity. Everything's great. Buy
more. Exactly. The short sellers are the only
ones who get paid to be pessimists. They're the
ones digging through the footnotes of financial
reports, looking for off -balance sheet exposures,
hidden debts, environmental liabilities, or just
plain old unsustainable business practices. Like
the guys who spotted the housing bubble in the
Big Short. Or the people who exposed the frauds
at Enron. Or Wirecard in Germany more recently.
By betting against these bad companies, they
can expose fraud or weakness far earlier than
the regulators might. They can stop unsustainable
practices by crushing the stock price before
the bubble gets even bigger and hurts even more
people when it finally pops. So they're the market's
detectives, or maybe bounty hunters, funded by
their own greed. Ideally, yes. That's the argument.
Okay, so that's a powerful case for the defense.
Speculators stabilize prices, they provide liquidity,
they bear risk, and they expose fraud. But it's
time to bring in the prosecution because we know
it's not all sunshine and stable corn prices.
No, it is not. If the defense's case is built
on efficiency, the prosecution's case is built
on chaos. And it rests its case on two main pillars,
something called the winner's curse and, of course,
the devastating nature of bubbles. OK, let's
start with the winner's curse. That sounds like
a bad game show prize. It usually applies to
auctions, but the principle is the same. Imagine
we're auctioning off a big jar of coins. No one
knows exactly how much money is inside. Everyone
in the room gets to write down a guess, a bid.
The person who wins the auction, the person with
the highest bid, is almost by definition the
person who guessed the highest number. Right.
Which means they were very likely the most overly
optimistic person in the room. They probably
bid more than the jar is actually worth. So by
winning the auction, they've actually lost money.
So the speculator who wins the trade, who manages
to buy the stock at its absolute peak, It's often
the one who is the most wrong about its value.
Exactly. This concept suggests that speculation
doesn't attract the smartest, most rational actors,
but instead the most irrational, overconfident
ones. And when you get enough of those irrational
people together in one market. You get a bubble.
You get an economic bubble. This is where the
real social harm comes in. The definition of
a bubble is simple. It's when the price of an
asset exceeds its intrinsic value by a significant
margin. And this is where the social epidemic
concept. from our sources comes into play. It's
not about fundamentals anymore. Not at all. It
becomes a feedback loop, a social virus. The
price starts to rise and that attracts media
attention. New, less informed buyers enter the
market simply because they see the price rising.
Their buying pushes the price up even more. It
generates more stories and attracts even more
buyers. It feeds on itself. It's driven by word
of mouth and the fear of missing out. FOMO. And
the argument here is that speculators are the
ones who fuel this fire. They pour gasoline on
it. They do. While the defense says speculators
stabilize prices based on hard information, the
prosecution argues that in a bubble, speculators
often ignore information and just follow the
crowd. They engage in herd behavior. They see
the price going up, so they buy, which makes
it go up more. This creates artificial volatility.
So instead of helping the market find the real
price, they're helping it create a fantasy price.
A fantasy price that is completely detached from
reality until inevitably it collapses. And when
it collapses, like in 1929 or the dotcom bust
or 2008, it hurts everyone. It doesn't just wipe
out the speculators. It destroys pensions. It
destroys jobs. It freezes up credit for small
businesses. The innocent bystanders get hit by
the shrapnel. There's a famous quote about this
from John Maynard Keynes. He seems to be the
central figure in this. this entire debate on
both sides. Keens is absolutely fascinating here.
In his 1936 masterpiece, The General Theory,
he wrote what might be the most famous line ever
about this. What was it? Speculators may do no
harm as bubbles on a steady stream of enterprise,
but the situation is serious when enterprise
becomes the bubble on a whirlpool of speculation.
When enterprise becomes the bubble on a whirlpool
of speculation. That is a poetic way to put it.
It's beautiful, isn't it? He was warning about
what happens when the act of speculation, the
casino, dominates the actual business of doing
business. When Wall Street becomes more important
than Main Street. When the tail wags the dog.
But here is where it gets really, really interesting.
And this is what I call the Keynes Paradox. Because
listening to that quote, you'd think Keynes was
some stuffy ivory tower academic who hated traders
and thought they were all villains. Not at all.
Keynes was a player. He was, and I say this with
respect, a degenerate gambler in the best possible
sense. He personally ran a precursor to a hedge
fund. It's called the chest fund for King's College,
Cambridge. So the guy who wrote the most famous
warning about the whirlpool was swimming in it
every day. And he was an Olympic level swimmer.
His fund averaged a 13 % profit per year. 13%.
That's great even today. It's phenomenal today.
Now, remember, he was doing this during the Great
Depression. The global markets were being absolutely
decimated and he was cranking out double digit
returns year after year. That's incredible performance.
How on earth did he do it? He was basically inventing
modern portfolio theory on the fly. He didn't
just buy and hold British stocks. He diversified.
He bought commodities. He traded currencies.
He bought U .S. stocks, which was considered
a risky emerging market back then. And he shorted
the market. He shorted. The very thing people
call unpatriotic. Oh, yeah. He sold borrowed
stocks to profit from market falls. He was constantly
looking for what he called opposed risks. So
the harshest critic of the whirlpool was actually
a master of using speculation to secure the financial
future of his college. That adds such a layer
of nuance. It's not speculation is bad. It's
more like speculation is powerful and dangerous,
so you better know what you're doing. Exactly.
He respected the beast because he had tamed it.
This brings us perfectly to the referee, the
government. If speculation is this double -edged
sword, essential for liquidity but dangerous
for creating bubbles, how have governments tried
to manage it over the years? It seems like a
nightmare to regulate. It has been a game of
whack -a -mole for 300 years, and we're still
playing it. We mentioned the Bubble Act of 1720
earlier. After the South Sea bubble. Right. Passed
in the UK at the absolute height of the panic.
It was designed to stop speculative schemes.
And amazingly, it stayed on the books for over
100 years until 1825. They basically tried to
ban the formation of new joint stock companies
without a royal charter. That is a long time
to hold a grudge against financial innovation.
Then you jump forward to the US. The next big
one is the Glass -Steagall Act, passed in 1933
in the depths of the Great Depression. Right.
And that separated commercial banking. Your deposits,
your mortgage, the safe money from investment
banking, which was the trading and the gambling.
Exactly. The idea was to build a firewall. And
that act was, as you know, largely repealed in
the 80s and 90s, which many people argue set
the stage for the 2008 financial crisis. But
let's look at an even more extreme view. The
Soviet Union. Oh, I can imagine they didn't look
too kindly on speculators. That's putting it
mildly. Article 154 of the Penal Code of the
USSR. Speculation. which they defined as pretty
much any private trade for profit, was a criminal
offense. Criminal, like go to jail criminal.
Go to jail, pay a fine, or be sentenced to corrective
labor. In the Soviet view, buying low and selling
high wasn't providing liquidity or price discovery.
It was parasitic. It was exploitation. You were
adding no value to the product, just extracting
wealth from the worker and the state. That is
the ultimate prosecution argument written into
law. It is. But in the U .S., we have a very
specific and frankly... very weird example of
regulation that I need to hear more about. The
Onion Futures Act. This is one of the oddest,
most specific carve outs in all of financial
law. And it's a true story. OK, lay it on me.
In the mid 1950s, a pair of speculators in Chicago,
one of them was a farmer turned trader named
Vincent Kosuga, essentially cornered the market
on onions. Cornered the market. That means they
bought all the available onions. They bought
up so many of the futures contracts that they
effectively controlled the entire national supply.
First, they drove the price way up. Then they
secretly built up a massive short position, betting
the price would fall. And then they flooded the
market. it with all their physical onions to
deliberately crash the price. They made a fortune
on the way up and a second fortune on the way
down. And what happened to the actual onion farmers?
They were devastated, completely wiped out. The
price of a 50 -pound bag of onions dropped to
something like 10 cents. The physical bags themselves
cost more than the onions inside them. Farmers
were literally dumping truckloads of onions into
the Chicago River because they couldn't even
afford to transport them. That is brutal. The
public outcry was deafening. The farmers marched
on Washington, and Congress passed the Onion
Futures Act in 1958. It specifically banned the
trading of futures contracts on onions. Just
onions, not potatoes or carrots. Specifically
onions. To this day, you can trade futures on
corn, oil, gold, pork bellies, weather patterns,
almost anything, but not onions. And that law
is still in effect. That is wild. It's like a
legislative monument to a single speculative
disaster, a never forget. for the onion farmers
of the 50s. Moving to the modern era, the next
big regulatory push came after 2008 with the
Dodd -Frank Act. This introduced a whole new
set of attempts to rein in the beast. What were
they trying to fix this time? A lot of things,
but one of the big targets was excessive speculation.
particularly in commodities. The CFTC proposed
something called position limits. Position limits.
It's basically a rule saying you, Mr. Hedge Fund,
cannot hold more than X percent of the world's
supply of oil or wheat or copper. So you're limiting
how big any single whale can be in the market.
So no one can do a Vincent Kosuga with oil and
corner the market again. That's the idea. And
then you also have the Volcker rule, which was
part of Dodd -Frank. That rule bans banks from
making speculative investments with their own
money. It's called proprietary trading if it
doesn't benefit their customers. The argument
was that big banks were gambling with the house's
money, which was implicitly backed by federally
insured deposits. When they won, they kept the
profits. When they lost big, the taxpayers had
to pay. to bail them out. Which seemed like a
pretty reasonable rule. If you want to speculate,
use your own cash, not the insured deposits of
grandmas and schoolteachers. That's the logic.
There have also been other proposals that never
quite made it into law, but they're always being
discussed, especially during crises. Like the
Tobin tax. Right, that's a small tax on financial
transactions. Yes, a tiny tax, maybe 0 .1 % on
every single currency trade. The idea is to throw
some sand in the gears of the machine. It wouldn't
hurt a long -term investor who buys something.
once a year, but it would make that high frequency,
purely speculative trading much less profitable.
It's designed to slow down the whirlpool. And
there were even serious talks of banning oil
speculation altogether. In 2008, when oil prices
spiked to $147 a barrel, German leaders, among
others, proposed a worldwide ban on oil trading
by speculators. They blamed hedge funds directly
for the high gas prices people were paying at
the pump. But... Going back to our hero defense,
if you ban speculators from the oil market, who
takes the risk from the airlines and the oil
producers? That is the trillion dollar counter
argument. If you ban the speculators, the oil
producers who need to sell and the airlines who
need to buy have no one to trade with. The market
freezes. The price might not be $147, but you
might not be able to buy oil at any price. The
liquidity vanishes. It really seems like we are
constantly trying to find this impossible Goldilocks
zone. We want the liquidity and the risk bearing,
but we don't want the bubbles and the crashes.
It is the eternal struggle of financial regulation.
You need the grease for the gears, but you don't
want the grease to catch on fire and burn the
whole factory down. And finding that perfect
balance is incredibly difficult, partly because
the market is always evolving faster than the
laws can keep up. So let's try to bring all of
this together. We've gone from tulip bulbs in
the frozen Dutch mud to high frequency trading
algorithms in New York data centers. We've seen
that speculators can be the villains who corner
the onion market, but they're also the silent
partners who allow a farmer to sleep at night
by buying his risk. It's a duality. You really
can't separate the two functions. The so -called
intelligence of the market relies on having all
these diverse actors with different motives.
You need the safety -seeking investor, the pragmatic
hedger, the opportunistic arbitrager, and the
risk -taking speculator. If you remove one leg
from that four -legged stool, the whole thing
just falls over. Precisely. The speculator is
the immune system of the market in some ways
and the virus in others. It's both. I want to
leave our listeners with a final thought experiment
on that. We so often talk about reducing risk
in the economy. We hate uncertainty. But imagine
we got what we wished for. Imagine a world where
all speculation was successfully banned tomorrow.
No one is allowed to buy anything unless they
intend to keep it for 10 years or consume it
immediately. It sounds safe. It sounds stable.
It sounds... Prudent? It sounds safe on the surface.
Yeah. But is it? If I'm that farmer and I can't
sell my corn futures to a speculator, I might
not plant the corn. If I'm an airline and I can't
hedge my fuel costs, I might have to cancel flights
or raise prices unpredictably. And if you just
want to sell your house because you got a new
job in a different city, but there are no speculators
or investors allowed to buy it, you might have
to wait three years to find a perfect buyer who
wants to live in that specific house. You're
stuck. the entire system becomes rigid. So the
provocative thought is this. Is the gambler,
the character we culturally look down on, actually
the very glue holding our entire secure world
together? Is their willingness to take a risk
the foundation of your safety? That is the paradox
at the heart of it all. We may not like them,
we may sneer at them, but we might just need
them more than we know. Something to think about
the next time you see a headline about Wall Street.
Thanks for diving in with us. Thank you. It was
a pleasure. We'll see you on the next Deep Dive.