Understanding speculation

SAM GREGG writes that the practice of speculation is morally justifiable as long as basic moral principles are followed. In specific conditions, he says, it can certainly have negative effects. Before Catholics condemn (or unreservedly praise) speculation, however, it’s important that we understand this important financial tool in all its complexity . . . 

Sam Gregg

Speculation is one of those words that raises many Christians’ hackles. It conjures up visions of people making easy gain for no apparent effort, and some associate it with financial crises.

So what’s a Christian to make of speculation? The Catechism of the Catholic Church identifies “speculation in which one contrives to manipulate the price of goods artificially in order to gain an advantage to the detriment of others” as “morally illicit” (CCC #2409).. This wording indicates that there are legitimate forms of speculation, though these are left unspecified.

The justice of different choices denoted as “speculative” depends upon the specifics of a given choice. Speculation that relies, for instance, upon telling falsehoods is wrong because choosing to lie is, in Christian terms, always wrong. It would be equally unjust for a financial firm to try and manipulate the futures market by expressing to others excessive optimism or negativity about the prospects for a given commodity.

These examples are very different from the type of speculation that involves making prudential judgments about what one buys and sells on the stock market in light of what one judges is likely to happen in the future on the basis of knowledge, experience and evidence. Speculation can be abused or used badly. But just because some banks issue credit to the wrong people doesn’t mean we should eliminate credit altogether, nor does misuse of speculative techniques necessitate a severe curtailing of speculation.

There are also greater and lesser degrees of speculation, depending on the size of the “bet” and how much one can reasonably forecast for the future. When a bank, for instance, grants a two-year small loan to an established business with a track record of on-time loan repayment, it does so with a high degree of certainty that the loan will be repaid.

The scale of the speculation — and the risk — increases in the case of, for instance, a hedge fund that chooses to borrow a large amount of money in order to speculate upon the future worth of a given commodity or currency over varying periods of time. “Forward dealings,” as they are called, seek to capitalize upon expected price movements that enable me to sell high and buy low. This can involve buying products, shares, or commodities in the expectation that, in the meantime, prices will fall (a “bear” transaction) or rise (a “bull” transaction). The degree of uncertainty surrounding all these factors means that the speculative risk is usually higher than a standard small-business loan.

Given the inevitable degree of speculation involved in any economic choice, it’s hard to see how speculation per se could be wrong in the sense that every act of adultery, for instance, is intrinsically evil. We should also recall that speculation involves taking a risk, and risk has always been understood as providing a just title to any ensuing profits.

Speculation, whether on currencies or commodities, is not a work- free exercise. When a hedge fund decides to go “long” or “short” on a commodity’s future price, it rarely does so because of someone’s mere whim. Such firms employ large numbers of forecasters, traders, and even mathematical modelers in an effort to make as accurate a speculative estimate as possible. Though often portrayed as an activity that results in enormous gain on the basis of little labor, speculation often involves quite large amounts of work undertaken by highly knowledgeable groups of people who may lose a great deal (including their jobs) if they make significant errors in judgment.

What’s important to note here is that someone’s ability to make a profit as a speculator does not emanate from cheating anyone — or from any magical ability on his part to make the price of necessities such as food increase and thereby put food outside the poor’s capacity to pay. Instead I derive a profit because I correctly estimate that, for instance, the demand for oil would be greater than the supply of oil over the future. Likewise, my loss would proceed from my failure to ascertain that the oil supply was going to outstrip demand in a year’s time.

We should also be attentive to the ways in which speculation can contribute to the better use of economic resources. Speculation —  be it in currencies, food, commodities — can, for instance, contribute to the relative stability of economic life by helping to calibrate the supply and demand of many goods beyond the short-term.

Much more could be said about speculation. In specific conditions, it can certainly have negative effects. But before Catholics condemn (or unreservedly praise) speculation, it’s important that we understand this financial tool in all its complexity. Only then can we render judgment on an act of speculation in the marketplace.

SAMUEL GREGG is the Acton Institute’s research director. His most recent book is “Tea Party Catholic.”