Tuesday, October 19, 2010

What a Speculator Is, and Is Not

These articles were exceedingly basic and lacked good enough explanations for the positive incentives of a free stock market. Due to this my peers seem to have maintained the typically sophomoric view of what speculation is, so I will attempt to outline a relevant distinction between what it is and what the historical and governmental perversions of it are.

Speculation is not buying or selling based on crests or troughs, at least it shouldn't be. Speculation is investment based on quantifiable signals such as current events business trends or known market demands. A practical investor will not merely invest in stock a or b, they will look to the various businesses for signs of good investment possibilities. The habit of 'trend' speculation is a stupid one. At our previous meeting David said that trend speculation was accurate fifty-one percent of the time. The idea that people will devote an exorbitant amount of capital in a practice of guessing the flip of a coin is STUPID. Regardless of how stupid or not this practice would be less common if actual speculators could make informed investments. This is where the government is typically to blame but rather than hopping on that bandwagon I will focus on a market based issue.

Let us look at the issue of creative accounting and Enron.
In the 1990s Enron and several other large firms went through scandals in which they employed 'creative accounting' and essentially lied about their profit margins in a manner that caused their businesses to expand and stock sales to soar. When this unsustainable practice failed as it was destined to, many lost large portions of their investment capital when the companies liquidated. Many will argue that greater government oversight would have prevented this and that in the event of failure the bailouts were necessary to protect people's investment capital.

This creates two prevalent issues: Moral Hazard and unwieldy government interference. Rather than employing a government solution let us examine a market based one. Without moral hazard investors will be less risky with their funds and unsustainable business practice becomes less prevalent. With this businesses will focus on long term viability.
An issue to this assertion with the long term viability argument is that some individuals who have very low morals and exceedingly high time preference and can still gain from a company that has to liquidate.(Those Pricks at Tyco) The market response to this used to be internal auditors. A problem however is that Enron's internal auditors were the ones lying and that perhaps auditing the company you work for entails some perverse incentives.

This is where creative destruction comes into play. The market can still adapt to these small issues and investors can demand companies hire reputable external audit companies. Any possible bad practices that these audit companies such as creative accounting or information privacy will be removed by the market.

Educated people have a natural goal of long term viability. With with the removal of moral hazards and the adaptation to market demands, they will move in the direction of pragmatism. The derogatory connotation of speculator is the antithesis of the pragmatist and merely the perverted stereotype.

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