Are Speculators to Blame?

Speculators operate in a market where for every buyer there must be a seller. If someone is speculating on the long side, there is someone speculating on the other side. Speculation can drive up prices in the very short run if buyers outnumber sellers. Similarly, prices can drop if sellers outnumber buyers. Over the long haul, these bumps and dips tend to level out.

But speculation isn't bad in and of itself. Imagine a farmer who's livelihood depends on him selling his wheat after harvest. Because he doesn't know where the market will be when the harvest comes, he wants to lock in a price now. It may be less than what he could get at harvest time if the market price moves up between now and then, but he figures a bird in the hand is worth two in the bush. By buying a futures contract now he can lock in a price and insulate himself from the risk.

If the price of wheat goes down, he made a good move by locking in the higher price. If it goes up, then he will be stuck with the lower price in his contract. In either case, for the farmer to reduce his risk he needs someone on the other side of that transaction to speculate, or, if you wish, gamble.

A similar transaction occurs when an airline locks up a certain quantity of fuel with a contract. Airline ticket price volatility is reduced (at least inasmuch as fuel affects the price) through speculation.

If you purchase a CD in order to lock in a rate you are speculating. You are saying you prefer a known rate to the unknown or the volatile. Buying gold is also speculation.

There is nothing evil about this transaction and it does a lot of good for the farmer, airline or investors because it allows them to plan with less uncertainty.

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