WEBVTT 00:00:00.000 --> 00:00:02.359 Welcome back to the Deep Dive. Today, we are 00:00:02.359 --> 00:00:06.719 putting a very specific word under the microscope. 00:00:06.960 --> 00:00:08.880 A very loaded word. A very loaded word, yeah. 00:00:08.939 --> 00:00:10.900 Yeah. It's a word that, if I'm being honest, 00:00:11.000 --> 00:00:12.599 usually comes with a bit of a sneer attached 00:00:12.599 --> 00:00:15.599 to it. It conjures up these images of, you know, 00:00:15.640 --> 00:00:19.039 shouting men in polyester suits on trading floors, 00:00:19.280 --> 00:00:21.980 bursting bubbles, maybe a villain in an Oliver 00:00:21.980 --> 00:00:24.199 Stone movie. Or that guy at the party. We all 00:00:24.199 --> 00:00:26.179 know that guy. Oh, that guy. Yeah. The guy who 00:00:26.179 --> 00:00:28.519 won't stop talking about crypto. Exactly. Exactly. 00:00:29.050 --> 00:00:32.030 We are talking about speculation. It certainly 00:00:32.030 --> 00:00:34.009 carries a tremendous amount of cultural baggage. 00:00:34.210 --> 00:00:36.549 It does. And usually when you hear someone called 00:00:36.549 --> 00:00:39.049 a speculator, it's not a compliment. It implies 00:00:39.049 --> 00:00:41.130 recklessness. It implies, you know, gambling, 00:00:41.350 --> 00:00:44.109 greed, profiting off something without actually. 00:00:44.649 --> 00:00:46.670 building anything. But we've pulled together 00:00:46.670 --> 00:00:48.670 a stack of sources today. We've gone through 00:00:48.670 --> 00:00:52.289 the Wikipedia entry on speculation, historical 00:00:52.289 --> 00:00:54.909 accounts of market manias from way back in the 00:00:54.909 --> 00:00:57.649 1600s and some really heavy hitting economic 00:00:57.649 --> 00:00:59.829 theories from the likes of Keynes and Graham. 00:01:00.070 --> 00:01:02.710 Right. And they all suggest that the reality 00:01:02.710 --> 00:01:05.829 is. Well, it's a lot more complicated. It is. 00:01:05.849 --> 00:01:08.750 The central tension we're going to explore today 00:01:08.750 --> 00:01:13.189 is really a question about the architecture of 00:01:13.189 --> 00:01:16.829 our world. Oh, so? Well, are speculators just 00:01:16.829 --> 00:01:19.469 reckless gamblers who cause financial crises 00:01:19.469 --> 00:01:24.810 and chaos? Are they actually the unsung essential 00:01:24.810 --> 00:01:27.950 heroes who keep the global economy from freezing 00:01:27.950 --> 00:01:31.209 up? OK, that is a massive claim. Heroes, really. 00:01:31.310 --> 00:01:33.290 It's the argument. Because my visceral reaction, 00:01:33.489 --> 00:01:36.390 and I think most people's, is no way. You know, 00:01:36.450 --> 00:01:38.709 you think of the 2008 crash, you think of gas 00:01:38.709 --> 00:01:41.189 prices spiking. Yeah. You blame the speculators. 00:01:41.349 --> 00:01:43.469 And that's the reputation, often for good reason. 00:01:43.569 --> 00:01:45.150 But we're going to try and look at the mechanics 00:01:45.150 --> 00:01:46.810 beneath the market movements. We're going to 00:01:46.810 --> 00:01:48.010 talk about tulips. We're going to talk about 00:01:48.010 --> 00:01:51.030 onions. Oh, yeah. Onions play a surprisingly 00:01:51.030 --> 00:01:53.739 large role. American Legal History, and we're 00:01:53.739 --> 00:01:55.780 going to talk about human psychology. I am still 00:01:55.780 --> 00:01:57.739 stuck on the onions, but okay, I'm sure we'll 00:01:57.739 --> 00:02:00.459 get there. So our mission today is to move beyond 00:02:00.459 --> 00:02:03.180 that pejorative definition and really unpack 00:02:03.180 --> 00:02:06.719 the machinery of risk, price, and value. Let's 00:02:06.719 --> 00:02:09.400 do it. So let's start with the basics. If we 00:02:09.400 --> 00:02:11.900 strip away all the emotion, all the baggage, 00:02:12.139 --> 00:02:15.759 what actually is speculation? Well, if we look 00:02:15.759 --> 00:02:18.199 at the standard definition, you know, the one 00:02:18.199 --> 00:02:20.659 used in finance and how our sources break it 00:02:20.659 --> 00:02:24.960 down, it's the purchase of an asset. An asset. 00:02:25.039 --> 00:02:27.860 So that could be anything. Anything. Like wheat, 00:02:28.020 --> 00:02:32.060 goods, real estate, stocks, you name it. But 00:02:32.060 --> 00:02:34.319 it's the purchase with the hope. The hope, not 00:02:34.319 --> 00:02:36.560 the certainty. Exactly. The hope that it will 00:02:36.560 --> 00:02:38.979 become more valuable in a brief amount of time. 00:02:39.080 --> 00:02:42.340 Okay. So hope and brief. Those seem like the 00:02:42.340 --> 00:02:44.539 two key words there. They're everything. And 00:02:44.539 --> 00:02:46.360 the most important distinction here is that the 00:02:46.360 --> 00:02:49.080 speculator is focusing purely on price movements. 00:02:49.780 --> 00:02:52.319 They aren't necessarily interested in the fundamental 00:02:52.319 --> 00:02:54.719 value. You mean like if a company actually makes 00:02:54.719 --> 00:02:57.400 a good product. Right. Or the utility of the 00:02:57.400 --> 00:02:58.979 thing they're buying. They don't really want 00:02:58.979 --> 00:03:00.860 to own it. Not in the traditional sense. They 00:03:00.860 --> 00:03:03.520 want to sort of. Rent the price movement. Rent 00:03:03.520 --> 00:03:05.740 the price movement. I like that. So let's use 00:03:05.740 --> 00:03:08.360 a classic analogy to make this concrete. Buying 00:03:08.360 --> 00:03:11.000 a house. Sure. Perfect example. If I buy a house 00:03:11.000 --> 00:03:13.139 because I want to live in it, raise a family, 00:03:13.300 --> 00:03:17.840 maybe plant a garden, that's utility. Yes. That's 00:03:17.840 --> 00:03:19.599 consumption or a very long -term investment. 00:03:19.800 --> 00:03:22.039 You care if the roof leaks. You care about the 00:03:22.039 --> 00:03:23.879 school district. Right. I'm buying the houseness 00:03:23.879 --> 00:03:26.120 of the house. Correct. You're consuming the asset. 00:03:27.069 --> 00:03:29.189 If you buy a house in a neighborhood because 00:03:29.189 --> 00:03:31.590 you read some blog post saying it's the next 00:03:31.590 --> 00:03:34.689 big thing. And your plan is to just paint the 00:03:34.689 --> 00:03:37.930 front door red and flip it in six months for 00:03:37.930 --> 00:03:40.509 a 20 percent profit without ever moving in. That 00:03:40.509 --> 00:03:42.389 is speculation. You don't care about the roof 00:03:42.389 --> 00:03:44.509 or the schools. Not really. You care about the 00:03:44.509 --> 00:03:46.569 price trajectory. You're betting on the belief 00:03:46.569 --> 00:03:49.430 of the next buyer. Got it. OK, that makes sense. 00:03:49.729 --> 00:03:53.189 But the market isn't just made up of speculators 00:03:53.189 --> 00:03:56.490 and. you know homeowners our sources break down 00:03:56.490 --> 00:03:58.909 the financial markets into four primary characters 00:03:58.909 --> 00:04:01.870 and i found this really helpful to visualize 00:04:01.870 --> 00:04:04.509 the ecosystem it's like a cast of characters 00:04:04.509 --> 00:04:07.569 in a play it is and this is crucial for understanding 00:04:07.569 --> 00:04:10.030 why the speculator exists you can't understand 00:04:10.030 --> 00:04:12.189 the speculator without understanding who they're 00:04:12.189 --> 00:04:14.270 trading with okay so who's character number one 00:04:14.270 --> 00:04:16.610 the first character is the hedger the hedger 00:04:16.610 --> 00:04:19.199 this sounds like the cautious one The responsible 00:04:19.199 --> 00:04:21.819 one. They are the pragmatists. The hedger is 00:04:21.819 --> 00:04:26.240 someone who transacts to offset a pre -existing 00:04:26.240 --> 00:04:28.740 risk. A pre -existing risk. What does that mean? 00:04:28.839 --> 00:04:32.100 The classic example is a farmer. Let's say you 00:04:32.100 --> 00:04:35.920 grow corn. Your entire financial life is terrifying. 00:04:36.259 --> 00:04:39.000 Right. Because you have all the costs up front. 00:04:39.060 --> 00:04:42.000 The seeds, the fertilizer, the diesel for the 00:04:42.000 --> 00:04:44.259 tractor. Yeah. But you have no idea what the 00:04:44.259 --> 00:04:46.519 price will be when you actually have the product 00:04:46.519 --> 00:04:49.540 to sell months later. Exactly. You plant in April. 00:04:49.660 --> 00:04:51.759 You harvest in October. What if the price of 00:04:51.759 --> 00:04:54.540 corn crashes in September? You go bankrupt. You 00:04:54.540 --> 00:04:56.939 lose the farm. That is a massive, massive risk. 00:04:57.199 --> 00:04:58.920 So what does the farmer do? How do they hedge? 00:04:59.079 --> 00:05:01.180 So a hedger, the farmer in this case, might go 00:05:01.180 --> 00:05:03.399 into the market and sell a contract to deliver 00:05:03.399 --> 00:05:05.779 that corn at a fixed price later in the year. 00:05:05.899 --> 00:05:08.060 So they lock in their price today. They lock 00:05:08.060 --> 00:05:11.660 it in. They are hedging their bet. Now, they 00:05:11.660 --> 00:05:14.480 give up the chance of a massive windfall if corn 00:05:14.480 --> 00:05:17.779 prices were to suddenly skyrocket to $10 a bushel. 00:05:17.839 --> 00:05:20.000 But they're safe. They're safe. They've protected 00:05:20.000 --> 00:05:23.779 themselves against a crash down to $2. They are 00:05:23.779 --> 00:05:26.980 buying certainty in an uncertain world. Okay, 00:05:27.019 --> 00:05:30.279 so hedger equals safety first. They're using 00:05:30.279 --> 00:05:33.439 the market to remove risk from their life. Who's 00:05:33.439 --> 00:05:36.449 character number two? Number two is the arbitrage. 00:05:36.629 --> 00:05:39.290 The arbitrage. I always feel like I need a monocle 00:05:39.290 --> 00:05:41.829 and a top hat to say that word. It sounds incredibly 00:05:41.829 --> 00:05:44.350 fancy, but the concept is actually very simple, 00:05:44.470 --> 00:05:47.230 very mechanical. OK. The arbitrage just seeks 00:05:47.230 --> 00:05:50.050 to profit from price differences for the exact 00:05:50.050 --> 00:05:52.410 same item in different markets. It's all about 00:05:52.410 --> 00:05:56.670 spotting inefficiency. So like. An example. Let's 00:05:56.670 --> 00:05:59.470 say gold is trading for $2 ,000 an ounce in London. 00:05:59.610 --> 00:06:02.750 And for some weird glitchy reason, it's trading 00:06:02.750 --> 00:06:06.189 for $2 ,005 in New York. So the same exact bar 00:06:06.189 --> 00:06:08.629 of gold has two different price tags depending 00:06:08.629 --> 00:06:10.670 on where you're standing. For a brief moment, 00:06:10.829 --> 00:06:13.829 yes. The arbitrage sees this instantly. Their 00:06:13.829 --> 00:06:16.449 computers see it. They buy it in London for $2 00:06:16.449 --> 00:06:18.709 ,000 and instantly sell it in New York for $2 00:06:18.709 --> 00:06:21.509 ,005. Then they pocket the $5. That feels like 00:06:21.509 --> 00:06:24.139 free money. Is it really that simple? It's essentially 00:06:24.139 --> 00:06:27.939 risk -free profit, yes, but it requires incredible 00:06:27.939 --> 00:06:31.439 speed and technology. And here's the social value 00:06:31.439 --> 00:06:33.819 of what they do. There's a social value. Absolutely. 00:06:34.060 --> 00:06:36.779 By doing that trade, they actually help equalize 00:06:36.779 --> 00:06:39.959 the prices. Their buying pushes the London price 00:06:39.959 --> 00:06:43.060 up a tiny bit, and their selling pushes the New 00:06:43.060 --> 00:06:46.319 York price down a tiny bit until that $5 gap 00:06:46.319 --> 00:06:48.720 closes. So they're like the market's referees. 00:06:49.100 --> 00:06:51.759 They keep the global market in sync. They enforce 00:06:51.759 --> 00:06:54.420 logic. That's a great way to put it. Yes. Got 00:06:54.420 --> 00:06:56.579 it. Okay. So hedgers and arbitragers, number 00:06:56.579 --> 00:06:59.100 three. Number three is the investor. This is 00:06:59.100 --> 00:07:01.120 the one we're probably most familiar with. The 00:07:01.120 --> 00:07:03.360 long gamer. The Warren Buffett type. Exactly. 00:07:03.740 --> 00:07:06.199 The investor seeks profit through the long term 00:07:06.199 --> 00:07:08.339 ownership of the instrument's underlying attributes. 00:07:08.740 --> 00:07:10.420 So this is the person buying a stock because 00:07:10.420 --> 00:07:12.899 they believe the company makes good cars or it's 00:07:12.899 --> 00:07:15.420 well managed or pays a good dividend. Precisely. 00:07:15.699 --> 00:07:18.920 They are looking at growth, earnings, yield. 00:07:19.160 --> 00:07:22.060 They plan to hold it for years, maybe decades. 00:07:22.459 --> 00:07:24.600 They treat the stock like they're owning a tiny 00:07:24.600 --> 00:07:26.800 piece of a business, not like a lottery ticket. 00:07:26.980 --> 00:07:30.230 And finally. That brings us to character number 00:07:30.230 --> 00:07:34.110 four, the star of our show today. The speculator. 00:07:34.250 --> 00:07:36.009 The speculator. So how do they fit in with these 00:07:36.009 --> 00:07:38.649 other three? Well, they're defined by what they're 00:07:38.649 --> 00:07:41.519 not. They don't have a crop to hedge. They aren't 00:07:41.519 --> 00:07:44.199 farmers. OK. They aren't looking for those tiny 00:07:44.199 --> 00:07:46.939 microsecond price gaps like the arbitrage. Right. 00:07:47.060 --> 00:07:49.839 And they aren't necessarily married to the long 00:07:49.839 --> 00:07:52.259 term success of the company like the investor. 00:07:52.420 --> 00:07:55.819 They trade purely to anticipate price movements. 00:07:56.100 --> 00:07:59.800 They are taking on risk voluntarily. Voluntarily. 00:07:59.899 --> 00:08:02.279 That's a key word. It is. They're taking on risk 00:08:02.279 --> 00:08:04.899 in exchange for potential profit. So if we look 00:08:04.899 --> 00:08:08.319 at the flow of energy here, the hedger, the farmer. 00:08:08.730 --> 00:08:11.750 is desperately trying to get rid of risk. The 00:08:11.750 --> 00:08:14.050 speculator is voluntarily walking in and taking 00:08:14.050 --> 00:08:16.129 it. That is the symbiotic relationship right 00:08:16.129 --> 00:08:18.129 there. And this is the core of the argument for 00:08:18.129 --> 00:08:20.509 why speculation is necessary. You cannot have 00:08:20.509 --> 00:08:23.029 a hedger who wants to sell their risk. Unless 00:08:23.029 --> 00:08:24.930 you have a speculator on the other side willing 00:08:24.930 --> 00:08:27.170 to buy it. We are definitely going to drill deep 00:08:27.170 --> 00:08:29.089 in that mechanism later because that sounds like 00:08:29.089 --> 00:08:31.629 the heart of the hero argument. It is. But before 00:08:31.629 --> 00:08:33.549 we get there, I want to touch on something our 00:08:33.549 --> 00:08:36.070 sources mentioned about the fuzzy line. Because 00:08:36.070 --> 00:08:38.429 hearing those four definitions, it all sounds 00:08:38.429 --> 00:08:41.610 very neat and clean. But in reality, isn't the 00:08:41.610 --> 00:08:43.750 difference between an investor and a speculator 00:08:43.750 --> 00:08:48.190 a little subjective? It is notoriously fuzzy. 00:08:48.370 --> 00:08:50.990 It's often a matter of time scale and self -perception. 00:08:51.470 --> 00:08:54.070 Even Benjamin Graham. The father of value investing. 00:08:54.529 --> 00:08:56.830 Warren Buffett's mentor. That's the one. He wrote 00:08:56.830 --> 00:08:58.990 about this in his famous book, The Intelligent 00:08:58.990 --> 00:09:01.250 Investor. The Bible of investing. Yeah. What 00:09:01.250 --> 00:09:03.549 was his take on it? Well, he struggled with it. 00:09:03.629 --> 00:09:06.490 He tried to draw a line. He defined the defensive 00:09:06.490 --> 00:09:09.309 investor as someone interested chiefly in safety 00:09:09.309 --> 00:09:12.289 and, quote, freedom from bother. Freedom from 00:09:12.289 --> 00:09:14.649 bother. I like that. But even he admitted that 00:09:14.649 --> 00:09:17.710 some speculation is. basically unavoidable. He 00:09:17.710 --> 00:09:20.350 said, essentially, that risk has to live somewhere. 00:09:20.549 --> 00:09:23.129 It must be assumed by someone. Right. If you 00:09:23.129 --> 00:09:25.009 buy a stock, even if you plan to hold it for 00:09:25.009 --> 00:09:27.370 10 years, there's no guarantee it goes up. I 00:09:27.370 --> 00:09:29.830 mean, huge companies have gone bankrupt. Kodak, 00:09:29.870 --> 00:09:32.610 General Motors. You're speculating on the future 00:09:32.610 --> 00:09:36.170 to some degree anytime you buy anything. Exactly. 00:09:36.170 --> 00:09:38.710 Graham pointed out that even long term buy and 00:09:38.710 --> 00:09:41.049 hold strategies can be classified as speculation 00:09:41.049 --> 00:09:43.669 unless your primary motivation is just income 00:09:43.669 --> 00:09:46.950 like from dividends or the safety of your principal. 00:09:47.269 --> 00:09:49.769 If you are secretly hoping the price doubles. 00:09:50.070 --> 00:09:52.450 Which everyone is. Which everyone is. Then there's 00:09:52.450 --> 00:09:54.409 a speculative element to what you're doing. It's 00:09:54.409 --> 00:09:56.909 a spectrum not a binary switch. And the regulatory 00:09:56.909 --> 00:09:59.850 body is like the CFTC. That's the Commodity Futures 00:09:59.850 --> 00:10:02.009 Trading Commission in the US. Correct. They have 00:10:02.009 --> 00:10:03.590 to have a stricter definition right. They can't 00:10:03.590 --> 00:10:05.769 just go by vibe. They can't look at a trader 00:10:05.769 --> 00:10:08.590 and say, hmm, he looks like he's hoping a little 00:10:08.590 --> 00:10:10.909 too much today. No, you can't regulate vibes. 00:10:11.090 --> 00:10:14.370 The CFTC keeps it very, very simple. For them, 00:10:14.429 --> 00:10:16.750 a speculator is a trader who does not hedge. 00:10:16.929 --> 00:10:19.950 We'll stop. Full stop. If you aren't a farmer 00:10:19.950 --> 00:10:22.409 protecting your crop or an airline protecting 00:10:22.409 --> 00:10:25.980 its future fuel costs. You are a speculator. 00:10:26.080 --> 00:10:27.940 It doesn't matter if you're a grandma buying 00:10:27.940 --> 00:10:30.659 one share of AT &T or a massive hedge fund buying 00:10:30.659 --> 00:10:33.639 a billion dollars of oil contracts. If you don't 00:10:33.639 --> 00:10:35.919 have a direct commercial interest in the physical 00:10:35.919 --> 00:10:39.679 underlying asset, you are, by definition, speculating. 00:10:39.860 --> 00:10:42.240 Simple as that. OK, so we know what they are. 00:10:42.320 --> 00:10:44.559 Now let's talk about where they came from, because 00:10:44.559 --> 00:10:46.500 this isn't a modern invention. This isn't some 00:10:46.500 --> 00:10:48.539 crypto bro thing. People have been betting on 00:10:48.539 --> 00:10:51.700 prices since. Yeah. Well, since we add prices. 00:10:51.820 --> 00:10:54.500 For centuries. The sources really highlight the 00:10:54.500 --> 00:10:57.220 17th century in the Netherlands as a major turning 00:10:57.220 --> 00:10:59.700 point. The Dutch. This is really where commodity 00:10:59.700 --> 00:11:02.419 markets as we know them were born. The Dutch 00:11:02.419 --> 00:11:05.220 were the absolute masters of trade. They invented 00:11:05.220 --> 00:11:08.759 the stock market, the central bank, and arguably 00:11:08.759 --> 00:11:11.960 the speculative bubble. And you cannot talk about 00:11:11.960 --> 00:11:14.059 17th century Dutch markets without talking about 00:11:14.059 --> 00:11:18.169 flowers. Tulip mania. 1634 to 1637. This story 00:11:18.169 --> 00:11:20.070 never gets old. It's like the original sin of 00:11:20.070 --> 00:11:22.049 finance. It is the archetype. It's the story 00:11:22.049 --> 00:11:24.830 everyone tells to warn about speculation. What's 00:11:24.830 --> 00:11:27.730 so fascinating is the mechanism behind it. The 00:11:27.730 --> 00:11:29.929 Dutch Calvinist society at the time had strictly 00:11:29.929 --> 00:11:32.830 banned gambling. Okay, so no casinos. No casinos, 00:11:32.830 --> 00:11:34.730 no betting on dice, so people needed an outlet 00:11:34.730 --> 00:11:36.710 for that risk -taking impulse. Yeah. And they 00:11:36.710 --> 00:11:41.520 turned to tulip bulbs. Which seems so. Wholesome. 00:11:41.520 --> 00:11:44.899 Flowers. Until you realize people were trading 00:11:44.899 --> 00:11:47.399 their houses and their life savings for a single 00:11:47.399 --> 00:11:50.559 root. For a single bulb. And specifically the 00:11:50.559 --> 00:11:53.320 most valuable ones were the broken bulbs. The 00:11:53.320 --> 00:11:55.820 ones with these beautiful fiery stripes, which 00:11:55.820 --> 00:11:59.419 we now know was actually caused by a virus infecting 00:11:59.419 --> 00:12:01.700 the bulb. So they were paying a premium for a 00:12:01.700 --> 00:12:05.259 sick flower. They were. But here's the technical 00:12:05.259 --> 00:12:07.039 innovation that really matters for our story. 00:12:07.559 --> 00:12:10.950 They were trading forward deals. Most of this 00:12:10.950 --> 00:12:13.149 frantic trading happened in the winter. And why 00:12:13.149 --> 00:12:14.909 does the season matter so much? Because in the 00:12:14.909 --> 00:12:17.090 winter, the bulbs are in the ground. They're 00:12:17.090 --> 00:12:19.610 dormant. You can't physically hand over the tulips. 00:12:19.610 --> 00:12:21.710 It doesn't exist yet, in a way. So what were 00:12:21.710 --> 00:12:23.950 they trading? They were trading pieces of paper, 00:12:24.110 --> 00:12:26.929 promises, contracts to deliver a specific tulip 00:12:26.929 --> 00:12:29.309 bulb in the spring. This was arguably the first 00:12:29.309 --> 00:12:32.450 widespread popular futures market. So they were 00:12:32.450 --> 00:12:34.509 speculating on the future price of a flower that 00:12:34.509 --> 00:12:36.549 was currently buried in the frozen mud. Exactly. 00:12:36.590 --> 00:12:39.289 The Dutch had a fantastic name for it. The wind 00:12:39.289 --> 00:12:42.070 handle. The wind trade. Literally, the wind trade, 00:12:42.110 --> 00:12:43.830 because they were trading nothing but air and 00:12:43.830 --> 00:12:46.590 the turnover was incredibly rapid. The sources 00:12:46.590 --> 00:12:49.169 say in places like Harlem and Amsterdam, people 00:12:49.169 --> 00:12:51.309 would meet in taverns. Not on some fancy exchange 00:12:51.309 --> 00:12:54.639 floor. No, in a pub. And these paper contracts 00:12:54.639 --> 00:12:57.600 would change hands 10 times a day. So I buy the 00:12:57.600 --> 00:12:59.980 paper from you for 100 guilders. I turn around 00:12:59.980 --> 00:13:01.720 and sell it to the guy at the next table for 00:13:01.720 --> 00:13:05.759 110. He sells it to his friend for 120. And the 00:13:05.759 --> 00:13:08.159 actual bulb hasn't moved an inch from under the 00:13:08.159 --> 00:13:11.000 snow. Precisely. And we all know how that story 00:13:11.000 --> 00:13:14.559 ended. In February 1637, the music stopped. Someone 00:13:14.559 --> 00:13:16.600 tried to sell, and for the first time, no one 00:13:16.600 --> 00:13:20.379 wanted to buy. Prices collapsed 90%, 95 % in 00:13:20.379 --> 00:13:23.759 a matter of days. A spectacular crash. But it 00:13:23.759 --> 00:13:25.740 didn't stop there. That wasn't the last bubble. 00:13:25.820 --> 00:13:28.200 The 18th century saw even bigger disasters, right? 00:13:28.320 --> 00:13:31.580 Oh, yes. The 1720s were a particularly bad decade 00:13:31.580 --> 00:13:33.840 for Europe. You had the South Sea bubble in England 00:13:33.840 --> 00:13:36.360 and the Mississippi Company in France, and they 00:13:36.360 --> 00:13:38.720 both collapsed at almost the exact same time 00:13:38.720 --> 00:13:41.740 around 1720. Now, these were massive corporate 00:13:41.740 --> 00:13:43.559 disasters, right? These weren't just flowers 00:13:43.559 --> 00:13:45.840 in a tavern. These were huge companies backed 00:13:45.840 --> 00:13:48.460 by the government. They were enormous. The South 00:13:48.460 --> 00:13:50.179 Sea Company was supposed to hold the monopoly 00:13:50.179 --> 00:13:52.899 on all trade with South America. Everyone invested, 00:13:53.080 --> 00:13:55.100 from the general public to the highest levels 00:13:55.100 --> 00:13:57.879 of government, even Sir Isaac Newton. Isaac Newton, 00:13:58.080 --> 00:14:01.139 the smartest man alive, the guy who invented 00:14:01.139 --> 00:14:04.340 calculus and figured out gravity. He lost a fortune, 00:14:04.500 --> 00:14:07.259 a life -changing amount of money. He famously 00:14:07.259 --> 00:14:10.049 said, I can calculate the motion of heavenly 00:14:10.049 --> 00:14:13.529 bodies, but not the madness of people. And these 00:14:13.529 --> 00:14:16.149 events, the South Sea and Mississippi collapses, 00:14:16.210 --> 00:14:18.750 were so devastating that they brought the entire 00:14:18.750 --> 00:14:21.490 concept of speculation into disrepute in Europe 00:14:21.490 --> 00:14:24.370 for generations. It became a dirty word. It was 00:14:24.370 --> 00:14:26.649 seen as a moral failing, not just a financial 00:14:26.649 --> 00:14:29.350 one. But it didn't disappear. It just evolved. 00:14:29.750 --> 00:14:33.450 And our sources point to a specific year, 1867, 00:14:33.730 --> 00:14:37.070 as a major technological shift. A moment that 00:14:37.070 --> 00:14:39.970 changed speculation from a sort of tavern activity 00:14:39.970 --> 00:14:43.350 into a global obsession. What happened in 1867? 00:14:43.610 --> 00:14:45.389 The invention of the stock ticker machine in 00:14:45.389 --> 00:14:48.610 New York. Ah, the ticker tape. That little chattering 00:14:48.610 --> 00:14:51.389 strip of paper you see in old movies. It seems 00:14:51.389 --> 00:14:54.250 so quaint now, doesn't it? But this was the Internet 00:14:54.250 --> 00:14:57.149 of its day. It was a revolution. How so? What 00:14:57.149 --> 00:15:00.009 did it change? Well, before the ticker, if you 00:15:00.009 --> 00:15:01.970 wanted to know the price of a stock or if you 00:15:01.970 --> 00:15:05.159 wanted to trade, you generally had to be. physically 00:15:05.159 --> 00:15:07.840 present at the exchange. Or you had to have a 00:15:07.840 --> 00:15:10.299 messenger boy running back and forth. So information 00:15:10.299 --> 00:15:12.639 traveled at the speed of a running child. Exactly. 00:15:13.000 --> 00:15:16.039 It was slow. It was exclusive. It was an insider's 00:15:16.039 --> 00:15:18.919 game. The ticker changed all of that. It democratized 00:15:18.919 --> 00:15:21.879 it. It democratized speculation. Suddenly you 00:15:21.879 --> 00:15:24.799 could be in a broker's office miles away or eventually 00:15:24.799 --> 00:15:27.700 in other cities and see the price almost in real 00:15:27.700 --> 00:15:30.740 time. It made the market a spectator sport for 00:15:30.740 --> 00:15:33.279 the entire country. It removed the need to be 00:15:33.279 --> 00:15:35.409 on the floor. And I assume this just exploded 00:15:35.409 --> 00:15:37.789 the number of people who were doing it. Significantly. 00:15:37.789 --> 00:15:40.490 The sources give us a truly staggering data point 00:15:40.490 --> 00:15:42.990 on this. In the year 1900, there were about 4 00:15:42.990 --> 00:15:45.789 .4 million shareholders in the United States. 00:15:45.830 --> 00:15:49.590 By 1932, just over 30 years later, that number 00:15:49.590 --> 00:15:54.629 had jumped to 26 million. Wow. From 4 to 26 million. 00:15:55.149 --> 00:15:57.149 So the ticker tape turned the market from an 00:15:57.149 --> 00:16:00.610 exclusive club into a national obsession. Precisely. 00:16:00.710 --> 00:16:02.870 And that brings us right back to the core conflict. 00:16:03.110 --> 00:16:06.629 As speculation grew, as it moved from the tavern 00:16:06.629 --> 00:16:09.269 to the living room, so did this huge debate. 00:16:09.509 --> 00:16:12.879 Is this good or is this bad for society? OK, 00:16:12.980 --> 00:16:15.220 let's play defense attorney first. Let's look 00:16:15.220 --> 00:16:18.620 at the argument for the speculator as hero. This 00:16:18.620 --> 00:16:20.860 sounds incredibly provocative, especially after 00:16:20.860 --> 00:16:22.840 talking about the wind trade and Isaac Newton 00:16:22.840 --> 00:16:25.200 losing his shirt. It is a view championed by 00:16:25.200 --> 00:16:28.080 economists like Nicholas Kaldor and the famous 00:16:28.080 --> 00:16:31.080 trader Victor Niederhofer. Their core argument 00:16:31.080 --> 00:16:34.120 is deeply counterintuitive. Which is? They claim 00:16:34.120 --> 00:16:36.480 that speculators actually stabilize prices rather 00:16:36.480 --> 00:16:38.460 than disrupt them. OK, you have to walk me through 00:16:38.460 --> 00:16:40.159 that, because when I think speculator, I think 00:16:40.159 --> 00:16:42.700 volatility. I think prices. jumping up and down 00:16:42.700 --> 00:16:45.200 like crazy because of rumors and panic. How on 00:16:45.200 --> 00:16:47.240 earth do they stabilize things? They do it through 00:16:47.240 --> 00:16:48.759 something called the sustainable consumption 00:16:48.759 --> 00:16:51.559 theory. Let's look at two scenarios to explain 00:16:51.559 --> 00:16:55.740 it. Scenario A, a shortage. Okay, let's say the 00:16:55.740 --> 00:16:58.019 wheat harvest is terrible this year. There's 00:16:58.019 --> 00:16:59.940 a drought in the Midwest. There's not enough 00:16:59.940 --> 00:17:02.279 wheat to go around for everyone. Right. Now, 00:17:02.360 --> 00:17:05.019 a speculator who studies this stuff for a living 00:17:05.019 --> 00:17:07.720 looks at the weather reports, sees the satellite 00:17:07.720 --> 00:17:10.660 data and realizes the harvest is going to be 00:17:10.660 --> 00:17:13.599 bad before the general public knows. So what 00:17:13.599 --> 00:17:15.940 do they do? They buy. They start buying wheat 00:17:15.940 --> 00:17:18.099 now, betting the price will be higher later. 00:17:18.359 --> 00:17:21.079 Exactly. Which drives the price up immediately. 00:17:21.359 --> 00:17:23.740 Right. And people get angry. They say, look at 00:17:23.740 --> 00:17:26.180 those greedy speculators in Chicago making bread 00:17:26.180 --> 00:17:29.059 more expensive for my family. Yes, that's the 00:17:29.059 --> 00:17:32.140 immediate reaction. But ask yourself, what happens 00:17:32.140 --> 00:17:34.359 when the price of bread goes up? Well, basic 00:17:34.359 --> 00:17:36.700 economics. People buy less of it. They conserve. 00:17:37.099 --> 00:17:39.240 You know, maybe a bakery bakes slightly smaller 00:17:39.240 --> 00:17:42.319 loaves, or families don't throw away the crusts. 00:17:42.319 --> 00:17:45.680 You make it last. You make it last. High prices 00:17:45.680 --> 00:17:49.930 force conservation. So that limited supply of 00:17:49.930 --> 00:17:52.250 wheat is consumed more slowly. It gets stretched 00:17:52.250 --> 00:17:55.990 out over the year. If the price had stayed artificially 00:17:55.990 --> 00:17:57.930 low because there were no speculators forcing 00:17:57.930 --> 00:18:00.490 it up early, people would have eaten through 00:18:00.490 --> 00:18:03.109 the supply at a normal rate. And suddenly in 00:18:03.109 --> 00:18:05.329 the middle of winter, there'd be zero wheat left. 00:18:05.809 --> 00:18:09.319 That's a famine. So the speculator. By raising 00:18:09.319 --> 00:18:11.779 the price early, it essentially forces society 00:18:11.779 --> 00:18:14.220 to ration the scarce supply so it doesn't run 00:18:14.220 --> 00:18:16.200 out completely. Correct. And there's a second 00:18:16.200 --> 00:18:19.640 effect. That high price sends a massive signal 00:18:19.640 --> 00:18:22.059 to other producers all over the world, like a 00:18:22.059 --> 00:18:24.039 bat signal. A bat signal for wheat. It says, 00:18:24.099 --> 00:18:26.200 hey, wheat is really expensive. Grow more. Or 00:18:26.200 --> 00:18:28.619 if you're in Argentina and have a surplus, import 00:18:28.619 --> 00:18:31.720 it to the U .S. It encourages new supply to come 00:18:31.720 --> 00:18:34.269 into the market to meet the demand. That is actually 00:18:34.269 --> 00:18:35.930 a really compelling argument. It's like the aha 00:18:35.930 --> 00:18:38.509 moment. The high prices we hate during a shortage 00:18:38.509 --> 00:18:40.970 are actually a survival mechanism. That's the 00:18:40.970 --> 00:18:43.769 theory. Now let's look at scenario B really quickly. 00:18:43.950 --> 00:18:46.150 A surplus. Let's say the harvest is massive. 00:18:46.250 --> 00:18:48.890 The silos are overflowing. The price is too high 00:18:48.890 --> 00:18:51.289 compared to this new reality. So the speculator 00:18:51.289 --> 00:18:54.529 sees this and bets the price will go down. They 00:18:54.529 --> 00:18:57.019 sell. They sell, which pushes the price down. 00:18:57.200 --> 00:18:59.519 And what do low prices do? They encourage people 00:18:59.519 --> 00:19:02.099 to buy more, to consume more, to export more. 00:19:02.240 --> 00:19:04.240 It helps clear the surplus so it doesn't all 00:19:04.240 --> 00:19:07.480 rot in the fields. So in this view, the speculator 00:19:07.480 --> 00:19:11.390 is just a really aggressive. really fast mechanism 00:19:11.390 --> 00:19:14.430 for finding the right price faster than anyone 00:19:14.430 --> 00:19:17.210 else. That is the argument. They process information 00:19:17.210 --> 00:19:20.690 weather, politics, shipping data, and they translate 00:19:20.690 --> 00:19:22.730 it into price. This is called price discovery. 00:19:23.130 --> 00:19:25.710 Without them, the price might be wrong for months, 00:19:25.890 --> 00:19:28.089 leading to huge misallocations of resources. 00:19:28.549 --> 00:19:30.049 Let's talk about another benefit the defense 00:19:30.049 --> 00:19:33.170 brings up. Liquidity. The outline mentions the 00:19:33.170 --> 00:19:35.369 pork belly example. I love that we're jumping 00:19:35.369 --> 00:19:37.970 from tulips and wheat to bacon. This is a classic, 00:19:38.029 --> 00:19:40.670 simple way to explain liquidity. Imagine a market 00:19:40.670 --> 00:19:42.589 for pork bellies, which is, you know, bacon, 00:19:42.730 --> 00:19:45.009 where the only participants are farmers who raise 00:19:45.009 --> 00:19:47.190 the pigs and butchers who sell the bacon. Okay. 00:19:47.369 --> 00:19:50.009 No speculators allowed. Just the makers and the 00:19:50.009 --> 00:19:52.190 users. Yeah. Your utility. What's wrong with 00:19:52.190 --> 00:19:54.759 that? The problem is timing. The farmer wants 00:19:54.759 --> 00:19:56.740 to sell when the pigs are ready, let's say on 00:19:56.740 --> 00:19:59.640 a Tuesday at 10 a .m. But the butcher wants to 00:19:59.640 --> 00:20:01.759 buy when his inventory is running low, which 00:20:01.759 --> 00:20:04.160 might be on a Thursday at 2 p .m. Their needs 00:20:04.160 --> 00:20:06.799 don't line up. They don't line up. And even if 00:20:06.799 --> 00:20:08.759 they happen to meet at the same time, the farmer 00:20:08.759 --> 00:20:11.519 might want to sell for $5 a pound, and the butcher 00:20:11.519 --> 00:20:13.799 only wants to pay $3. And since there's nobody 00:20:13.799 --> 00:20:17.150 else around? No deal. Exactly. Because there 00:20:17.150 --> 00:20:20.109 are so few of them, the gap between what the 00:20:20.109 --> 00:20:22.049 farmer wants to sell for and what the butcher 00:20:22.049 --> 00:20:24.470 wants to pay, that's called the bid -ask spread, 00:20:24.670 --> 00:20:27.890 it might be huge. Without speculators, the market 00:20:27.890 --> 00:20:31.650 is illiquid. It's hard to do a deal. You might 00:20:31.650 --> 00:20:33.769 be stuck with your pigs. So end of the speculator. 00:20:33.930 --> 00:20:36.849 The speculator fills that gap. They provide a 00:20:36.849 --> 00:20:39.549 constant presence in the market. They are willing 00:20:39.549 --> 00:20:42.650 to buy from the farmer on Tuesday at 10 a .m., 00:20:42.650 --> 00:20:45.569 hold the risk for two days, and sell to the butcher 00:20:45.569 --> 00:20:48.230 on Thursday. They provide capital. They narrow 00:20:48.230 --> 00:20:50.549 that spread. They ensure that if you want to 00:20:50.549 --> 00:20:52.630 sell, there's always someone there to buy instantly. 00:20:52.950 --> 00:20:54.690 And if you want to buy, there's someone there 00:20:54.690 --> 00:20:57.160 to sell. That is liquidity. So they're the grease 00:20:57.160 --> 00:20:59.460 in the gears. They make sure the whole machine 00:20:59.460 --> 00:21:01.720 doesn't just grind to a halt. That's a perfect 00:21:01.720 --> 00:21:04.220 way to describe it. A liquid market is a safer, 00:21:04.240 --> 00:21:06.539 more efficient market for everyone else who uses 00:21:06.539 --> 00:21:08.779 it. And then there's the risk bearing aspect. 00:21:09.000 --> 00:21:11.359 We touched on this with the farmer earlier, but 00:21:11.359 --> 00:21:13.180 I want to make sure we really nail this down 00:21:13.180 --> 00:21:16.000 because this is arguably their most important 00:21:16.000 --> 00:21:19.240 social function. It absolutely is. Let's go back 00:21:19.240 --> 00:21:20.960 to the farmer and the corn scenario. Let's really 00:21:20.960 --> 00:21:23.680 look at the psychology of that farmer. He is 00:21:23.680 --> 00:21:26.380 terrified. He has loans to pay for his tractor, 00:21:26.519 --> 00:21:29.660 for his land. If the price of corn drops to $2 00:21:29.660 --> 00:21:33.099 a bushel, he loses everything. So in the face 00:21:33.099 --> 00:21:36.099 of that risk, he might just choose not to plant 00:21:36.099 --> 00:21:38.799 at all. He might say, it's too risky this year. 00:21:38.839 --> 00:21:40.990 I'll just leave the field empty. Which is bad 00:21:40.990 --> 00:21:43.109 for everyone because, you know, we all like to 00:21:43.109 --> 00:21:47.390 eat. Exactly. Society needs the corn. So a speculator 00:21:47.390 --> 00:21:49.670 steps in, maybe a guy in Chicago who has never 00:21:49.670 --> 00:21:52.130 seen a corn stalk in his life, and he says to 00:21:52.130 --> 00:21:54.950 the farmer, I will sign a contract today to buy 00:21:54.950 --> 00:21:57.690 all of your corn in October for $4 a bushel. 00:21:57.890 --> 00:22:00.250 Now, the speculator is taking a massive gamble. 00:22:00.789 --> 00:22:03.529 If the price of corn drops to $2 by October, 00:22:03.789 --> 00:22:06.880 the speculator has to buy it for $4. And loses 00:22:06.880 --> 00:22:10.440 a ton of money. Yes. The speculator takes a blow 00:22:10.440 --> 00:22:13.720 to the face. But the farmer. The farmer is safe. 00:22:13.980 --> 00:22:17.579 The farmer is safe. He is hedged. He can go to 00:22:17.579 --> 00:22:19.940 the bank, show them the contract, get a loan 00:22:19.940 --> 00:22:22.819 for his seeds. He plants the corn. Production 00:22:22.819 --> 00:22:25.880 increases. The speculator effectively acts as 00:22:25.880 --> 00:22:28.460 an insurance company for the producer. When you 00:22:28.460 --> 00:22:30.740 put it that way, it does sound heroic. I mean, 00:22:30.759 --> 00:22:33.000 someone has to hold a hot potato of risk. And 00:22:33.000 --> 00:22:34.720 the speculator is the one who says, throw it 00:22:34.720 --> 00:22:36.549 to me. Throw it to me. I think I can handle it. 00:22:36.609 --> 00:22:38.789 Now, sometimes they can't and they go bust. But 00:22:38.789 --> 00:22:41.609 the key is that the farmer, the producer, survives. 00:22:41.910 --> 00:22:43.690 Okay. There's one more argument for the defense, 00:22:43.829 --> 00:22:46.069 and it's a controversial one. It involves shorting. 00:22:46.109 --> 00:22:49.289 Ah, yes. Shorting. Betting against a company. 00:22:50.190 --> 00:22:52.890 Betting the price will go down. This is usually 00:22:52.890 --> 00:22:55.269 seen as the ultimate villain move. People say, 00:22:55.289 --> 00:22:57.470 you want American business to fail. It's often 00:22:57.470 --> 00:23:00.329 vilified, yeah. But you're saying there's a social 00:23:00.329 --> 00:23:03.430 good here. A huge one. Hedge funds that specialize 00:23:03.430 --> 00:23:05.609 in shorting can act as the canary in the coal 00:23:05.609 --> 00:23:08.069 mine for the entire economy. How so? Because 00:23:08.069 --> 00:23:10.609 they have a direct financial incentive to find 00:23:10.609 --> 00:23:14.549 the rot. Think about it. Everyone else, the company 00:23:14.549 --> 00:23:16.809 CEO, the investment bankers selling the stock, 00:23:16.930 --> 00:23:20.509 the traditional investors who own it, everyone 00:23:20.509 --> 00:23:22.930 is incentivized to be optimistic. It's an echo 00:23:22.930 --> 00:23:25.910 chamber of positivity. Everything's great. Buy 00:23:25.910 --> 00:23:29.250 more. Exactly. The short sellers are the only 00:23:29.250 --> 00:23:31.869 ones who get paid to be pessimists. They're the 00:23:31.869 --> 00:23:33.650 ones digging through the footnotes of financial 00:23:33.650 --> 00:23:36.369 reports, looking for off -balance sheet exposures, 00:23:36.390 --> 00:23:39.390 hidden debts, environmental liabilities, or just 00:23:39.390 --> 00:23:42.450 plain old unsustainable business practices. Like 00:23:42.450 --> 00:23:44.170 the guys who spotted the housing bubble in the 00:23:44.170 --> 00:23:46.589 Big Short. Or the people who exposed the frauds 00:23:46.589 --> 00:23:49.369 at Enron. Or Wirecard in Germany more recently. 00:23:49.930 --> 00:23:51.890 By betting against these bad companies, they 00:23:51.890 --> 00:23:54.690 can expose fraud or weakness far earlier than 00:23:54.690 --> 00:23:57.190 the regulators might. They can stop unsustainable 00:23:57.190 --> 00:23:59.390 practices by crushing the stock price before 00:23:59.390 --> 00:24:01.710 the bubble gets even bigger and hurts even more 00:24:01.710 --> 00:24:04.250 people when it finally pops. So they're the market's 00:24:04.250 --> 00:24:07.589 detectives, or maybe bounty hunters, funded by 00:24:07.589 --> 00:24:10.289 their own greed. Ideally, yes. That's the argument. 00:24:10.569 --> 00:24:12.349 Okay, so that's a powerful case for the defense. 00:24:13.430 --> 00:24:16.170 Speculators stabilize prices, they provide liquidity, 00:24:16.529 --> 00:24:20.559 they bear risk, and they expose fraud. But it's 00:24:20.559 --> 00:24:23.400 time to bring in the prosecution because we know 00:24:23.400 --> 00:24:25.740 it's not all sunshine and stable corn prices. 00:24:26.000 --> 00:24:29.680 No, it is not. If the defense's case is built 00:24:29.680 --> 00:24:32.039 on efficiency, the prosecution's case is built 00:24:32.039 --> 00:24:35.900 on chaos. And it rests its case on two main pillars, 00:24:36.119 --> 00:24:38.819 something called the winner's curse and, of course, 00:24:38.920 --> 00:24:41.700 the devastating nature of bubbles. OK, let's 00:24:41.700 --> 00:24:43.319 start with the winner's curse. That sounds like 00:24:43.319 --> 00:24:45.880 a bad game show prize. It usually applies to 00:24:45.880 --> 00:24:48.220 auctions, but the principle is the same. Imagine 00:24:48.220 --> 00:24:50.759 we're auctioning off a big jar of coins. No one 00:24:50.759 --> 00:24:52.740 knows exactly how much money is inside. Everyone 00:24:52.740 --> 00:24:55.079 in the room gets to write down a guess, a bid. 00:24:55.240 --> 00:24:58.059 The person who wins the auction, the person with 00:24:58.059 --> 00:25:00.700 the highest bid, is almost by definition the 00:25:00.700 --> 00:25:02.480 person who guessed the highest number. Right. 00:25:02.579 --> 00:25:05.059 Which means they were very likely the most overly 00:25:05.059 --> 00:25:07.259 optimistic person in the room. They probably 00:25:07.259 --> 00:25:09.799 bid more than the jar is actually worth. So by 00:25:09.799 --> 00:25:11.720 winning the auction, they've actually lost money. 00:25:11.859 --> 00:25:14.779 So the speculator who wins the trade, who manages 00:25:14.779 --> 00:25:17.700 to buy the stock at its absolute peak, It's often 00:25:17.700 --> 00:25:19.680 the one who is the most wrong about its value. 00:25:19.880 --> 00:25:22.400 Exactly. This concept suggests that speculation 00:25:22.400 --> 00:25:25.160 doesn't attract the smartest, most rational actors, 00:25:25.279 --> 00:25:27.680 but instead the most irrational, overconfident 00:25:27.680 --> 00:25:29.900 ones. And when you get enough of those irrational 00:25:29.900 --> 00:25:32.559 people together in one market. You get a bubble. 00:25:32.720 --> 00:25:34.519 You get an economic bubble. This is where the 00:25:34.519 --> 00:25:37.240 real social harm comes in. The definition of 00:25:37.240 --> 00:25:39.980 a bubble is simple. It's when the price of an 00:25:39.980 --> 00:25:43.619 asset exceeds its intrinsic value by a significant 00:25:43.619 --> 00:25:45.859 margin. And this is where the social epidemic 00:25:45.859 --> 00:25:48.440 concept. from our sources comes into play. It's 00:25:48.440 --> 00:25:50.500 not about fundamentals anymore. Not at all. It 00:25:50.500 --> 00:25:53.859 becomes a feedback loop, a social virus. The 00:25:53.859 --> 00:25:55.940 price starts to rise and that attracts media 00:25:55.940 --> 00:25:59.119 attention. New, less informed buyers enter the 00:25:59.119 --> 00:26:01.259 market simply because they see the price rising. 00:26:01.579 --> 00:26:04.240 Their buying pushes the price up even more. It 00:26:04.240 --> 00:26:06.119 generates more stories and attracts even more 00:26:06.119 --> 00:26:09.000 buyers. It feeds on itself. It's driven by word 00:26:09.000 --> 00:26:13.150 of mouth and the fear of missing out. FOMO. And 00:26:13.150 --> 00:26:15.789 the argument here is that speculators are the 00:26:15.789 --> 00:26:18.369 ones who fuel this fire. They pour gasoline on 00:26:18.369 --> 00:26:21.509 it. They do. While the defense says speculators 00:26:21.509 --> 00:26:24.849 stabilize prices based on hard information, the 00:26:24.849 --> 00:26:27.390 prosecution argues that in a bubble, speculators 00:26:27.390 --> 00:26:29.789 often ignore information and just follow the 00:26:29.789 --> 00:26:32.509 crowd. They engage in herd behavior. They see 00:26:32.509 --> 00:26:34.470 the price going up, so they buy, which makes 00:26:34.470 --> 00:26:37.240 it go up more. This creates artificial volatility. 00:26:37.599 --> 00:26:39.519 So instead of helping the market find the real 00:26:39.519 --> 00:26:41.759 price, they're helping it create a fantasy price. 00:26:41.940 --> 00:26:44.299 A fantasy price that is completely detached from 00:26:44.299 --> 00:26:47.220 reality until inevitably it collapses. And when 00:26:47.220 --> 00:26:49.940 it collapses, like in 1929 or the dotcom bust 00:26:49.940 --> 00:26:53.119 or 2008, it hurts everyone. It doesn't just wipe 00:26:53.119 --> 00:26:55.220 out the speculators. It destroys pensions. It 00:26:55.220 --> 00:26:57.299 destroys jobs. It freezes up credit for small 00:26:57.299 --> 00:27:00.259 businesses. The innocent bystanders get hit by 00:27:00.259 --> 00:27:02.019 the shrapnel. There's a famous quote about this 00:27:02.019 --> 00:27:03.960 from John Maynard Keynes. He seems to be the 00:27:03.960 --> 00:27:06.049 central figure in this. this entire debate on 00:27:06.049 --> 00:27:08.410 both sides. Keens is absolutely fascinating here. 00:27:08.490 --> 00:27:10.869 In his 1936 masterpiece, The General Theory, 00:27:11.109 --> 00:27:13.450 he wrote what might be the most famous line ever 00:27:13.450 --> 00:27:16.329 about this. What was it? Speculators may do no 00:27:16.329 --> 00:27:18.730 harm as bubbles on a steady stream of enterprise, 00:27:19.170 --> 00:27:22.170 but the situation is serious when enterprise 00:27:22.170 --> 00:27:24.869 becomes the bubble on a whirlpool of speculation. 00:27:24.890 --> 00:27:28.190 When enterprise becomes the bubble on a whirlpool 00:27:28.190 --> 00:27:31.140 of speculation. That is a poetic way to put it. 00:27:31.180 --> 00:27:33.539 It's beautiful, isn't it? He was warning about 00:27:33.539 --> 00:27:36.000 what happens when the act of speculation, the 00:27:36.000 --> 00:27:38.880 casino, dominates the actual business of doing 00:27:38.880 --> 00:27:41.779 business. When Wall Street becomes more important 00:27:41.779 --> 00:27:44.339 than Main Street. When the tail wags the dog. 00:27:44.680 --> 00:27:46.960 But here is where it gets really, really interesting. 00:27:47.240 --> 00:27:50.660 And this is what I call the Keynes Paradox. Because 00:27:50.660 --> 00:27:52.680 listening to that quote, you'd think Keynes was 00:27:52.680 --> 00:27:56.140 some stuffy ivory tower academic who hated traders 00:27:56.140 --> 00:27:58.420 and thought they were all villains. Not at all. 00:27:58.460 --> 00:28:01.200 Keynes was a player. He was, and I say this with 00:28:01.200 --> 00:28:03.920 respect, a degenerate gambler in the best possible 00:28:03.920 --> 00:28:06.579 sense. He personally ran a precursor to a hedge 00:28:06.579 --> 00:28:09.259 fund. It's called the chest fund for King's College, 00:28:09.400 --> 00:28:11.779 Cambridge. So the guy who wrote the most famous 00:28:11.779 --> 00:28:13.720 warning about the whirlpool was swimming in it 00:28:13.720 --> 00:28:15.579 every day. And he was an Olympic level swimmer. 00:28:15.660 --> 00:28:19.140 His fund averaged a 13 % profit per year. 13%. 00:28:19.519 --> 00:28:22.259 That's great even today. It's phenomenal today. 00:28:22.359 --> 00:28:24.559 Now, remember, he was doing this during the Great 00:28:24.559 --> 00:28:27.180 Depression. The global markets were being absolutely 00:28:27.180 --> 00:28:29.859 decimated and he was cranking out double digit 00:28:29.859 --> 00:28:32.819 returns year after year. That's incredible performance. 00:28:33.240 --> 00:28:36.660 How on earth did he do it? He was basically inventing 00:28:36.660 --> 00:28:39.930 modern portfolio theory on the fly. He didn't 00:28:39.930 --> 00:28:42.789 just buy and hold British stocks. He diversified. 00:28:42.809 --> 00:28:45.329 He bought commodities. He traded currencies. 00:28:45.329 --> 00:28:47.670 He bought U .S. stocks, which was considered 00:28:47.670 --> 00:28:51.130 a risky emerging market back then. And he shorted 00:28:51.130 --> 00:28:53.609 the market. He shorted. The very thing people 00:28:53.609 --> 00:28:57.309 call unpatriotic. Oh, yeah. He sold borrowed 00:28:57.309 --> 00:29:00.410 stocks to profit from market falls. He was constantly 00:29:00.410 --> 00:29:03.150 looking for what he called opposed risks. So 00:29:03.150 --> 00:29:05.490 the harshest critic of the whirlpool was actually 00:29:05.490 --> 00:29:08.009 a master of using speculation to secure the financial 00:29:08.009 --> 00:29:10.450 future of his college. That adds such a layer 00:29:10.450 --> 00:29:13.470 of nuance. It's not speculation is bad. It's 00:29:13.470 --> 00:29:15.569 more like speculation is powerful and dangerous, 00:29:15.630 --> 00:29:17.289 so you better know what you're doing. Exactly. 00:29:17.309 --> 00:29:19.869 He respected the beast because he had tamed it. 00:29:19.970 --> 00:29:23.210 This brings us perfectly to the referee, the 00:29:23.210 --> 00:29:26.789 government. If speculation is this double -edged 00:29:26.789 --> 00:29:29.410 sword, essential for liquidity but dangerous 00:29:29.410 --> 00:29:32.589 for creating bubbles, how have governments tried 00:29:32.589 --> 00:29:34.529 to manage it over the years? It seems like a 00:29:34.529 --> 00:29:36.869 nightmare to regulate. It has been a game of 00:29:36.869 --> 00:29:38.829 whack -a -mole for 300 years, and we're still 00:29:38.829 --> 00:29:41.210 playing it. We mentioned the Bubble Act of 1720 00:29:41.210 --> 00:29:44.119 earlier. After the South Sea bubble. Right. Passed 00:29:44.119 --> 00:29:46.380 in the UK at the absolute height of the panic. 00:29:46.559 --> 00:29:48.900 It was designed to stop speculative schemes. 00:29:49.259 --> 00:29:51.900 And amazingly, it stayed on the books for over 00:29:51.900 --> 00:29:55.880 100 years until 1825. They basically tried to 00:29:55.880 --> 00:29:58.000 ban the formation of new joint stock companies 00:29:58.000 --> 00:30:00.579 without a royal charter. That is a long time 00:30:00.579 --> 00:30:02.279 to hold a grudge against financial innovation. 00:30:02.619 --> 00:30:04.579 Then you jump forward to the US. The next big 00:30:04.579 --> 00:30:07.279 one is the Glass -Steagall Act, passed in 1933 00:30:07.279 --> 00:30:09.359 in the depths of the Great Depression. Right. 00:30:09.420 --> 00:30:12.329 And that separated commercial banking. Your deposits, 00:30:12.529 --> 00:30:14.809 your mortgage, the safe money from investment 00:30:14.809 --> 00:30:16.829 banking, which was the trading and the gambling. 00:30:17.029 --> 00:30:20.269 Exactly. The idea was to build a firewall. And 00:30:20.269 --> 00:30:22.829 that act was, as you know, largely repealed in 00:30:22.829 --> 00:30:24.950 the 80s and 90s, which many people argue set 00:30:24.950 --> 00:30:27.529 the stage for the 2008 financial crisis. But 00:30:27.529 --> 00:30:30.289 let's look at an even more extreme view. The 00:30:30.289 --> 00:30:33.289 Soviet Union. Oh, I can imagine they didn't look 00:30:33.289 --> 00:30:35.789 too kindly on speculators. That's putting it 00:30:35.789 --> 00:30:38.890 mildly. Article 154 of the Penal Code of the 00:30:38.890 --> 00:30:42.539 USSR. Speculation. which they defined as pretty 00:30:42.539 --> 00:30:45.980 much any private trade for profit, was a criminal 00:30:45.980 --> 00:30:48.119 offense. Criminal, like go to jail criminal. 00:30:48.240 --> 00:30:51.119 Go to jail, pay a fine, or be sentenced to corrective 00:30:51.119 --> 00:30:54.180 labor. In the Soviet view, buying low and selling 00:30:54.180 --> 00:30:57.000 high wasn't providing liquidity or price discovery. 00:30:57.240 --> 00:31:00.039 It was parasitic. It was exploitation. You were 00:31:00.039 --> 00:31:02.200 adding no value to the product, just extracting 00:31:02.200 --> 00:31:04.420 wealth from the worker and the state. That is 00:31:04.420 --> 00:31:06.779 the ultimate prosecution argument written into 00:31:06.779 --> 00:31:09.059 law. It is. But in the U .S., we have a very 00:31:09.059 --> 00:31:11.619 specific and frankly... very weird example of 00:31:11.619 --> 00:31:13.619 regulation that I need to hear more about. The 00:31:13.619 --> 00:31:16.140 Onion Futures Act. This is one of the oddest, 00:31:16.140 --> 00:31:18.420 most specific carve outs in all of financial 00:31:18.420 --> 00:31:21.400 law. And it's a true story. OK, lay it on me. 00:31:21.740 --> 00:31:25.240 In the mid 1950s, a pair of speculators in Chicago, 00:31:25.599 --> 00:31:28.400 one of them was a farmer turned trader named 00:31:28.400 --> 00:31:31.380 Vincent Kosuga, essentially cornered the market 00:31:31.380 --> 00:31:33.579 on onions. Cornered the market. That means they 00:31:33.579 --> 00:31:35.640 bought all the available onions. They bought 00:31:35.640 --> 00:31:38.079 up so many of the futures contracts that they 00:31:38.079 --> 00:31:40.619 effectively controlled the entire national supply. 00:31:40.940 --> 00:31:44.660 First, they drove the price way up. Then they 00:31:44.660 --> 00:31:47.859 secretly built up a massive short position, betting 00:31:47.859 --> 00:31:50.859 the price would fall. And then they flooded the 00:31:50.859 --> 00:31:52.819 market. it with all their physical onions to 00:31:52.819 --> 00:31:55.779 deliberately crash the price. They made a fortune 00:31:55.779 --> 00:31:58.160 on the way up and a second fortune on the way 00:31:58.160 --> 00:32:00.500 down. And what happened to the actual onion farmers? 00:32:00.779 --> 00:32:03.660 They were devastated, completely wiped out. The 00:32:03.660 --> 00:32:05.920 price of a 50 -pound bag of onions dropped to 00:32:05.920 --> 00:32:07.980 something like 10 cents. The physical bags themselves 00:32:07.980 --> 00:32:10.519 cost more than the onions inside them. Farmers 00:32:10.519 --> 00:32:13.059 were literally dumping truckloads of onions into 00:32:13.059 --> 00:32:14.500 the Chicago River because they couldn't even 00:32:14.500 --> 00:32:16.960 afford to transport them. That is brutal. The 00:32:16.960 --> 00:32:19.519 public outcry was deafening. The farmers marched 00:32:19.519 --> 00:32:22.059 on Washington, and Congress passed the Onion 00:32:22.059 --> 00:32:25.779 Futures Act in 1958. It specifically banned the 00:32:25.779 --> 00:32:28.279 trading of futures contracts on onions. Just 00:32:28.279 --> 00:32:31.619 onions, not potatoes or carrots. Specifically 00:32:31.619 --> 00:32:35.059 onions. To this day, you can trade futures on 00:32:35.059 --> 00:32:38.940 corn, oil, gold, pork bellies, weather patterns, 00:32:39.019 --> 00:32:41.880 almost anything, but not onions. And that law 00:32:41.880 --> 00:32:44.099 is still in effect. That is wild. It's like a 00:32:44.099 --> 00:32:46.740 legislative monument to a single speculative 00:32:46.740 --> 00:32:50.509 disaster, a never forget. for the onion farmers 00:32:50.509 --> 00:32:53.269 of the 50s. Moving to the modern era, the next 00:32:53.269 --> 00:32:56.329 big regulatory push came after 2008 with the 00:32:56.329 --> 00:32:58.990 Dodd -Frank Act. This introduced a whole new 00:32:58.990 --> 00:33:01.250 set of attempts to rein in the beast. What were 00:33:01.250 --> 00:33:03.710 they trying to fix this time? A lot of things, 00:33:03.769 --> 00:33:06.390 but one of the big targets was excessive speculation. 00:33:07.119 --> 00:33:10.160 particularly in commodities. The CFTC proposed 00:33:10.160 --> 00:33:12.740 something called position limits. Position limits. 00:33:12.960 --> 00:33:15.380 It's basically a rule saying you, Mr. Hedge Fund, 00:33:15.599 --> 00:33:17.680 cannot hold more than X percent of the world's 00:33:17.680 --> 00:33:20.420 supply of oil or wheat or copper. So you're limiting 00:33:20.420 --> 00:33:22.880 how big any single whale can be in the market. 00:33:23.180 --> 00:33:26.500 So no one can do a Vincent Kosuga with oil and 00:33:26.500 --> 00:33:28.380 corner the market again. That's the idea. And 00:33:28.380 --> 00:33:30.019 then you also have the Volcker rule, which was 00:33:30.019 --> 00:33:33.339 part of Dodd -Frank. That rule bans banks from 00:33:33.339 --> 00:33:35.500 making speculative investments with their own 00:33:35.500 --> 00:33:38.440 money. It's called proprietary trading if it 00:33:38.440 --> 00:33:41.019 doesn't benefit their customers. The argument 00:33:41.019 --> 00:33:43.240 was that big banks were gambling with the house's 00:33:43.240 --> 00:33:46.079 money, which was implicitly backed by federally 00:33:46.079 --> 00:33:49.180 insured deposits. When they won, they kept the 00:33:49.180 --> 00:33:52.440 profits. When they lost big, the taxpayers had 00:33:52.440 --> 00:33:54.430 to pay. to bail them out. Which seemed like a 00:33:54.430 --> 00:33:56.289 pretty reasonable rule. If you want to speculate, 00:33:56.470 --> 00:33:59.230 use your own cash, not the insured deposits of 00:33:59.230 --> 00:34:01.450 grandmas and schoolteachers. That's the logic. 00:34:01.670 --> 00:34:03.849 There have also been other proposals that never 00:34:03.849 --> 00:34:06.210 quite made it into law, but they're always being 00:34:06.210 --> 00:34:09.190 discussed, especially during crises. Like the 00:34:09.190 --> 00:34:11.409 Tobin tax. Right, that's a small tax on financial 00:34:11.409 --> 00:34:15.809 transactions. Yes, a tiny tax, maybe 0 .1 % on 00:34:15.809 --> 00:34:18.789 every single currency trade. The idea is to throw 00:34:18.789 --> 00:34:21.030 some sand in the gears of the machine. It wouldn't 00:34:21.030 --> 00:34:22.989 hurt a long -term investor who buys something. 00:34:23.050 --> 00:34:25.670 once a year, but it would make that high frequency, 00:34:25.909 --> 00:34:28.670 purely speculative trading much less profitable. 00:34:28.909 --> 00:34:31.409 It's designed to slow down the whirlpool. And 00:34:31.409 --> 00:34:33.449 there were even serious talks of banning oil 00:34:33.449 --> 00:34:36.510 speculation altogether. In 2008, when oil prices 00:34:36.510 --> 00:34:40.349 spiked to $147 a barrel, German leaders, among 00:34:40.349 --> 00:34:43.650 others, proposed a worldwide ban on oil trading 00:34:43.650 --> 00:34:46.809 by speculators. They blamed hedge funds directly 00:34:46.809 --> 00:34:49.190 for the high gas prices people were paying at 00:34:49.190 --> 00:34:52.340 the pump. But... Going back to our hero defense, 00:34:52.639 --> 00:34:56.380 if you ban speculators from the oil market, who 00:34:56.380 --> 00:34:58.579 takes the risk from the airlines and the oil 00:34:58.579 --> 00:35:01.440 producers? That is the trillion dollar counter 00:35:01.440 --> 00:35:03.780 argument. If you ban the speculators, the oil 00:35:03.780 --> 00:35:05.800 producers who need to sell and the airlines who 00:35:05.800 --> 00:35:08.420 need to buy have no one to trade with. The market 00:35:08.420 --> 00:35:12.260 freezes. The price might not be $147, but you 00:35:12.260 --> 00:35:14.699 might not be able to buy oil at any price. The 00:35:14.699 --> 00:35:16.800 liquidity vanishes. It really seems like we are 00:35:16.800 --> 00:35:19.760 constantly trying to find this impossible Goldilocks 00:35:19.760 --> 00:35:22.539 zone. We want the liquidity and the risk bearing, 00:35:22.719 --> 00:35:24.679 but we don't want the bubbles and the crashes. 00:35:24.860 --> 00:35:27.219 It is the eternal struggle of financial regulation. 00:35:27.800 --> 00:35:29.900 You need the grease for the gears, but you don't 00:35:29.900 --> 00:35:31.559 want the grease to catch on fire and burn the 00:35:31.559 --> 00:35:33.840 whole factory down. And finding that perfect 00:35:33.840 --> 00:35:36.340 balance is incredibly difficult, partly because 00:35:36.340 --> 00:35:38.610 the market is always evolving faster than the 00:35:38.610 --> 00:35:40.630 laws can keep up. So let's try to bring all of 00:35:40.630 --> 00:35:43.269 this together. We've gone from tulip bulbs in 00:35:43.269 --> 00:35:46.329 the frozen Dutch mud to high frequency trading 00:35:46.329 --> 00:35:49.250 algorithms in New York data centers. We've seen 00:35:49.250 --> 00:35:51.750 that speculators can be the villains who corner 00:35:51.750 --> 00:35:53.949 the onion market, but they're also the silent 00:35:53.949 --> 00:35:56.389 partners who allow a farmer to sleep at night 00:35:56.389 --> 00:35:59.409 by buying his risk. It's a duality. You really 00:35:59.409 --> 00:36:01.849 can't separate the two functions. The so -called 00:36:01.849 --> 00:36:04.289 intelligence of the market relies on having all 00:36:04.289 --> 00:36:06.309 these diverse actors with different motives. 00:36:06.530 --> 00:36:09.070 You need the safety -seeking investor, the pragmatic 00:36:09.070 --> 00:36:12.530 hedger, the opportunistic arbitrager, and the 00:36:12.530 --> 00:36:15.090 risk -taking speculator. If you remove one leg 00:36:15.090 --> 00:36:16.969 from that four -legged stool, the whole thing 00:36:16.969 --> 00:36:19.219 just falls over. Precisely. The speculator is 00:36:19.219 --> 00:36:20.940 the immune system of the market in some ways 00:36:20.940 --> 00:36:24.139 and the virus in others. It's both. I want to 00:36:24.139 --> 00:36:25.719 leave our listeners with a final thought experiment 00:36:25.719 --> 00:36:28.699 on that. We so often talk about reducing risk 00:36:28.699 --> 00:36:32.880 in the economy. We hate uncertainty. But imagine 00:36:32.880 --> 00:36:35.659 we got what we wished for. Imagine a world where 00:36:35.659 --> 00:36:38.239 all speculation was successfully banned tomorrow. 00:36:38.480 --> 00:36:40.500 No one is allowed to buy anything unless they 00:36:40.500 --> 00:36:42.739 intend to keep it for 10 years or consume it 00:36:42.739 --> 00:36:45.380 immediately. It sounds safe. It sounds stable. 00:36:45.539 --> 00:36:48.760 It sounds... Prudent? It sounds safe on the surface. 00:36:49.000 --> 00:36:52.460 Yeah. But is it? If I'm that farmer and I can't 00:36:52.460 --> 00:36:55.099 sell my corn futures to a speculator, I might 00:36:55.099 --> 00:36:57.860 not plant the corn. If I'm an airline and I can't 00:36:57.860 --> 00:37:00.380 hedge my fuel costs, I might have to cancel flights 00:37:00.380 --> 00:37:02.800 or raise prices unpredictably. And if you just 00:37:02.800 --> 00:37:04.800 want to sell your house because you got a new 00:37:04.800 --> 00:37:07.320 job in a different city, but there are no speculators 00:37:07.320 --> 00:37:10.119 or investors allowed to buy it, you might have 00:37:10.119 --> 00:37:12.460 to wait three years to find a perfect buyer who 00:37:12.460 --> 00:37:14.940 wants to live in that specific house. You're 00:37:14.940 --> 00:37:18.429 stuck. the entire system becomes rigid. So the 00:37:18.429 --> 00:37:21.369 provocative thought is this. Is the gambler, 00:37:21.369 --> 00:37:24.030 the character we culturally look down on, actually 00:37:24.030 --> 00:37:27.449 the very glue holding our entire secure world 00:37:27.449 --> 00:37:30.150 together? Is their willingness to take a risk 00:37:30.150 --> 00:37:33.690 the foundation of your safety? That is the paradox 00:37:33.690 --> 00:37:35.670 at the heart of it all. We may not like them, 00:37:35.710 --> 00:37:37.829 we may sneer at them, but we might just need 00:37:37.829 --> 00:37:40.250 them more than we know. Something to think about 00:37:40.250 --> 00:37:41.889 the next time you see a headline about Wall Street. 00:37:42.250 --> 00:37:44.269 Thanks for diving in with us. Thank you. It was 00:37:44.269 --> 00:37:45.989 a pleasure. We'll see you on the next Deep Dive.