Speculation

Speculation is the purchase or sale of an asset chiefly in the hope of profiting from a change in its price, rather than to use it, to earn steady income from it or to protect against a risk. A speculator buys land expecting it to be rezoned, buys a currency expecting it to strengthen, or sells oil futures expecting the price to fall. Speculation happens in shares, bonds, currencies, a commodity such as wheat or copper, property, art and crypto-assets, and it can take the form of a long bet on a rise or a short bet on a fall.

The line between speculation and investment is blurred. A common working distinction is that investors focus on the income and long-run value an asset produces, while speculators focus on short-term price movements and accept greater risk. Speculation is also distinguished from hedging, which uses the same instruments to reduce an existing risk, and from gambling, which creates a risk that would not otherwise exist. Economists study the demand for money held in readiness for such opportunities as the speculative motive.

A farmer who sells next year's harvest in advance at a fixed price is protecting himself against a price collapse. The person on the other side of that deal, who has no farm and no use for wheat, is a speculator: he is betting that wheat will be worth more by harvest time than the price he has agreed.

The farmer sleeps better because someone else has taken the worry. The speculator may make money or lose it. Whether society benefits depends on whether speculators, on the whole, guess well and calm prices, or chase each other and make prices swing harder.

Economists generally agree that speculators perform useful functions in well-functioning markets:

• Bearing risk. Producers and users of commodities, exporters and lenders can transfer price risk to speculators through a futures contract or forward contract. Without someone willing to take the other side, hedging would be costly or impossible.
• Adding liquidity. Speculative trading increases volume and narrows the bid-ask spread in the secondary market.
• Price discovery. Speculators who research supply and demand bring information into prices sooner, aiding price discovery and linking the spot price with expected future prices.
• Smoothing over time. Buying when goods are cheap and plentiful and selling when they are scarce can, in principle, reduce price swings.

Milton Friedman argued in 1953 that profitable speculation must on average be stabilizing, because speculators who buy high and sell low lose money and leave the market. Critics replied that this need not hold if some speculators profit by riding trends while others lose, or if traders can profit from anticipating what others will do rather than from fundamentals.

John Maynard Keynes, in his General Theory of 1936, warned that when "enterprise becomes the bubble on a whirlpool of speculation" the allocation of capital suffers. He compared professional investing to a newspaper beauty contest in which entrants try to pick not the prettiest face but the one others will pick. This view, and the role of animal spirits, is central to Keynesian economics and to behavioral economics.

Episodes often cited as speculative manias include the Dutch tulip trade of 1636 to 1637 (although some historians argue its scale has been exaggerated), Britain's South Sea Bubble of 1720, the US stock boom before 1929, the dot-com boom of the late 1990s and the US housing boom before the 2008 financial crisis. In each case an economic bubble formed as rising prices drew in buyers whose main reason for buying was that prices had risen. The economist Hyman Minsky described how long calm periods encourage borrowing for speculation until a Minsky moment triggers forced selling. More recent examples include the crypto bubble of 2021 and the trading of meme coins.

In currency markets, large flows of hot money can force a currency off its peg, as when speculators bet against sterling in September 1992 or against several Asian currencies in 1997. Governments often blame speculators for such crises, while many economists argue that speculators were reacting to unsustainable policies rather than causing them.

Policymakers rarely try to ban speculation outright, but they limit its scale and side effects:

• Position limits. In the United States, the Commodity Futures Trading Commission sets limits on the speculative positions any trader may hold in key commodity futures, under a rule finalized in 2020.
• Margin and leverage limits. Higher margin requirements make speculation on borrowed money more expensive; regulators can raise them in overheated markets.
• Transaction taxes. A small tax on trades, such as a Tobin tax on currency deals, is proposed to discourage very short-term trading. Several countries tax share trades, including the UK's stamp duty.
• Capital and housing measures. Some countries use capital controls against speculative inflows and higher property taxes for buyers who do not live in the homes they buy.

Views remain divided. Free-market economists tend to see speculation as an essential part of price formation and risk-sharing, while others, from Keynesian and post-Keynesian traditions, see excessive speculation as a source of volatility and financial instability that justifies regulation.

• CFTC: Speculative limits