The widespread economic belief that all forms of investment are beneficial because they help develop the economy while creating jobs is becoming less and less true. In this world of ours, which is increasingly dominated by greed, there are many ways to make money, and with the development of computer-based trading, the rate at which money is moved around from place to place and from one kind of financial investment to another is constantly increasing. Instead of continuing to spout false epithets like savings equals investment, in the sense of capital formation, economists need to get out in the real world and observe what actually happens when people invest their money, or entrust it to others to invest on their behalf. For then they would find that the human world, which is changing at faster and faster rates, is diverging more and more from their models and theories of human behaviour. If these models and theories were ever correct, they are presently becoming obsolete, and in some cases rendered completely false, by the rapid rate at which new human behaviours and products are developing.

The popularity of gambling, lotteries, betting on races and sporting events, and other games of chance or skill shows that there is a significant portion of the human population that is willing to take the chance of winning large sums of money, even though the losers invariably outnumber the winners, meaning that most of the participants lose money in the long run. Impatient with more safe and traditional forms of investment, such as government securities, which usually pay only a small return over a long time that is measured in years or decades, many investors have begun to seek new ways to earn more money in a shorter period of time. Of course, the problem with this approach is that the greater the potential profit, then generally the greater is the risk involved, including the possibility that one will lose all or even more than one’s initial investment, if one has borrowed money in the belief that one will assuredly make money by speculating.

Whereas in the past, the harm that a reckless investor, merchant, trader, or profiteer could cause to others was limited by the slows methods of communication, the limited number of contacts one could develop, the inherent limitations on the size of companies, the total wealth one could accumulate, and the influence that one’s actions or advice could have on others, the overcoming of these traditional limits due to technological developments in recent decades has greatly increased the harm that can be caused by a reckless individual, or by a group of reckless individuals or companies who all copy each other and do the same thing, so that when something goes wrong, their collective mistake becomes multiplied or magnified many, many times. That this is not merely a purely theoretical concern has been shown by financial crises like the one that began in the United States in 2008 and spread to other parts of the world. It is precisely because economists and financial analysts, in their mathematical models, analyses, and predictions, have failed to take into consideration the simple fact that human beings are influenced by what they see and hear of others doing that has sometimes led them to underestimate the risks involved in financial transactions and markets.

The price of a stock or of a tangible asset such as land or a piece of art is determined by the market’s demand for it. In an economy awash with money and investors looking for quick returns, that demand is substantially influenced by speculators’ expectations that other speculators will continue to push up the price. Nicholas F. Brady, who served as U.S. treasury secretary under President George Bush, observed, “If the assets were gold or oil, this phenomenon would be called inflation. In stocks, it is called wealth creation.” The process tends to feed on itself. As the price of an asset rises, more speculators are drawn to the action and the price continues to increase, attracting still more speculators—until the bubble bursts as when the crash of the overinflated Mexican stock market caused the 1995 peso crisis.[1]

Although speculators can provide needed cash or liquidity to the participants in the economy, and they can also help people such as retirees and others to earn money on their investments, they can also have a disruptive effect on the economy when they intervene more and more aggressively in order to make as much money in as short a time period as possible. And since they are prone to the innate human tendency to imitate and conform just like everyone else, their collective actions can cause a collapse in prices that can have significant harmful effects on the economy, while increasing the risk of a calamitous economic event.

All speculative bubbles arise for the same reason, and they also burst for the same reason, namely, the imitation of the model of making money, sometimes lots of money, in a short period of time. As more and more people hear about it, this attracts greater numbers of people who buy the item in question, believing that its price will continue to go up, based on nothing more than the fact that its price has gone up in the recent past. So long as there is a steady increase in the number of buyers, the price will continue to increase. But clearly the number of buyers cannot continue to increase forever. When this point is reached, then the price will cease to rise. If the number of buyers roughly equals the number of sellers, then the price can remain stable for a period of time. But if the sellers outnumber the buyers, as can happen if there are many owners of the item who want to realize their gains and recoup their money, or they are forced to sell to pay back their creditors who loaned them money, then the price will start to drop, with the possibility that it will drop precipitately. This is more likely to occur in the case of financial products whose only use is to make money, since the owners have no other reason to hold on to them, unlike with more practical things like grain, real estate, and gold, which have other uses besides that of making money.

The financial gamblers who increasingly control the financial world are opposed to regulations of any kind because it would greatly hamper them in their maniacal quest to make as much money as possible. Considering that most of the money with which they gamble or speculate on a daily basis is not theirs, it is not hard to see why they are so adamantly opposed to regulation. It is as if poker players played with money and for stakes which, for the most part, were put up by someone else. While they stand to gain significantly if they win, they will lose nothing except their reputations if they lose. The result is that, as more and more money is being funnelled into increasingly speculative financial products like derivatives, credit default swaps, collateralized debt obligations, futures contracts, currency arbitrage, stock shares, and so forth, the size of the national or global financial jackpot continues to grow larger every year. In the same way, a lottery jackpot becomes bigger when there are more and more buyers of lottery tickets. It is this – and not the acumen, intelligence, or experience of financial analysts, traders, and investment bankers – which explains why, in recent years and decades, the financial sector has been able to produce larger and larger profits. The financial acumen, ability, or experience of individual analysts, traders, and bankers only determines which of them will be able to get more of the jackpot than others, just as the skill, ability, and experience of poker players determines which of them will win more money than the other players. Of course, luck also plays a role in financial matters, just as it does in games of chance like poker.

The extremely naive and frequently false free-market belief that, whenever one is investing one’s own or other people’s money, one will always be cautious and not take unwise risks is certainly not true of gambling, where a person can be carried away by the lure of potentially large monetary gains and gamble all one’s money away, even to the point of becoming indebted, as one desperately tries to win back the large sums that one has so very foolishly lost. Such irrational and reckless behaviour also occurs in the world of business and financial investment, and to say otherwise is to be blinded to what happens in the real world by one’s ideological beliefs about human behaviour, as so many advocates of free-market policies are. When it is a question of investing other people’s money rather than one’s own, then the likelihood increases that one will make rash decisions or take on too much risk, especially given the very large amounts of money that can be made by taking such risks. Even if the majority of individuals or a company’s executives are responsible and level-headed people, the continually increasing sums of money that can be made in this increasingly global financial game of speculation can corrupt some of the players, transforming them into money addicts who will do whatever is necessary, including breaking the law, lying to or cheating their clients, or recklessly gambling their company’s or clients’ money away, to make as much money as possible in order to satisfy their addiction.

The resulting policies pushed corporate profits to previously unimaginable levels. With so much more money in their pockets than could be absorbed by productive investments, Swedish investors turned to speculation, driving up the prices of real estate, art, stamps, and other speculative goods. To stop the upward spiral, the government loosened monetary controls so that the excess funds could spill over into Europe. Money flowed out at such a rate that it helped push real estate prices in London and Brussels to record highs. As the speculative bubble fed on itself, the quick profits offered by speculation drained funds away from productive investments within Sweden. When the bubble in Swedish real estate finally burst, the Swedish banking system lost $18 billion in uncollectible loans. The bill was picked up by the state and passed on to the Swedish taxpayers.[2]

The important lesson to be learned from all speculative market collapses, regardless of the commodity in question, whether it is stocks, gold, art, or real estate, is that the bubble becomes dangerously inflated when people are allowed to buy the commodity with borrowed money, for this temporarily increases the demand by artificially increasing the number of buyers, which drives the price even higher. But the higher the price, then the farther it can fall when there are no new buyers, which increases the possibility of a panic when many owners try to sell the item at any price in order to recoup some of their money. In both cases – in both the rise and fall of the commodity’s price – we see the effect of imitation on the participants’ behaviour: they buy because they see the price of the commodity continually increasing, which evokes their greed, and they sell because they see the price continually declining, which evokes their fear. Both of these recurrent behaviours are examples of herd behaviours that are due to our innate human tendencies to imitate and conform to the behaviour of other people.

If people are buying something with their savings, that is, with money they don’t need at the present time, then they will have less need to get their money back and therefore they do not need to sell the commodity immediately. But when they are buying the commodity with borrowed money, then it is not entirely up to them when they decide to sell it, since the lender may demand one’s money back at any time. If there are many such people, then the effect of the price decline is greatly magnified, causing a precipitous drop, as happened in the New York Stock Exchange in 1929, when many people were allowed to buy stocks by paying as little as ten percent of the nominal value of the stocks, so great and widespread was the optimistic belief that stock prices would continue to rise forever, which greatly increased the possibility of a panic when their prices began to fall.

Banks and other financial institutions lend out money in order to make money from the savings that are entrusted to them by their depositors. Increasingly, the trend has been to use these savings to purchase more risky “investments” like derivatives in the expectation that the profits from them will be higher. Like many other people in the financial world, bankers have also gotten caught up in the mania for making as much money as possible in as short a time as possible, thereby abandoning the cautious, staid, boring, risk-averse, and dependable behaviour that characterized them in the past.

What we are seeing presently all over the world is the development of a global financial casino, where many different players, both big and small in terms of how much money they control, seat themselves at their computers and join the gambling table of global finance in order to try their luck and skill to see which of them can win the most money from the other players by outwitting them. For the most part, this financial gambling is not productive, just as ordinary gambling also does not produce much economic growth. But whereas ordinary gambling is a closed world, in the sense that what happens there does not have any effect on prices or events outside of these games, speculative “investment” can cause significant market distortions that send the wrong signal to producers, while resulting in higher prices for consumers. And this is because the things that financial speculators buy and sell – real estate, commodities, oil, land, energy, grain, coffee, food, and so forth – are things that are used and consumed by people who do not participate in their speculative activities, but who need or want these things, whose prices can be affected by speculation, in order to work, survive, and live their lives.

In 2006, food and oil prices rose sharply: Wheat rose by 80 percent, maize by 90 percent, rice by 320 percent, and oil prices doubled. The rise in prices meant that the poor could not afford basic foodstuffs or fuel for cooking, triggering riots in countries like Bangladesh and Haiti. The UN’s Jean Ziegler called it “silent mass murder.”

Explanations focused on increased demand from emerging countries like China and India, lower supply, including growing demand for bio-fuels, trade protectionism, subsidies, and low productivity. But according to the International Grain Council, global wheat production increased and demand for grain fell during the period. The rises were due, in part, to the financialization of the commodity market and speculation.

In the late 1980s, as commodities because a class of investment, traders bet on volatile commodity prices. Banks produced research reports, developed trading strategies and set up specialist funds to invest in food, energy, agriculture, and water. Rather than real investment in commodities, derivatives were used to bet on commodity prices. Banks and traditional commodity traders gained unprecedented ability to control markets or manipulate prices through operations spanning the entire supply chain—land ownership, production, trading physical commodities, storing, transportation, refining, sales, and trading derivatives.

[…] On regulated U.S. exchanges speculators held 64 percent of all open wheat contracts. In July 2010, Armajaro, a London-based hedge fund, purchased 7 percent of the world’s annual cocoa-bean production (240,100 tonnes) for $1 billion, promoting complaints of market manipulation.[3]

It is important to discredit the common but frequently inaccurate belief that large corporations create jobs, for the reality is that, overall, at least in the United States, large publicly-owned corporations do not create jobs. And the reason is because, although many corporations do regularly hire new workers, they also seek to automate their production or the services they provide, which practice eliminates many jobs, while they also cut large numbers of jobs for various reasons, such as to maintain or increase their profits or to reduce their losses.[4]

One of the most pernicious fictions promoted by the Wall Street propaganda—embraced unblinkingly by most politicians—depicts the stock market as the miraculous engine of job creation. The reality is nearly the opposite. It is not the 10,000 or so publicly traded companies that produce America’s job growth, but the hundreds of thousands of smaller, less celebrated companies that are privately owned and not even listed on any stock exchange. Frank Borges of Landmark Partners, which invests direct-equity capital in the private companies, said that during the most recent five-year-period these privately held firms generated virtually all of the net new jobs in the country with growth of roughly 20 percent, while the Fortune 500 companies were shrinking their employment by 4 percent. If more American capital flowed into the smaller enterprises and less to the larger ones, the economy would not suffer but benefit.[5]

Instead of using their savings in productive ways that create jobs and increase economic activity, as the out-of-touch-with-reality economists would have us believe, there are many people, such as the super-wealthy, who are using their savings in order to gamble in the global financial casino. Since this is the case, it makes absolutely no sense not to tax these speculative gains, both in order to increase government revenue, which is a constant and growing need in most countries around the world, as well as to dampen and restrain this kind of speculation, which can inflate prices and cause speculative bubbles and financial crises when it is allowed to proceed unchecked, as the very foolish free-market advocates of deregulation constantly urge us to do.

 

[1] When Corporations Rule the World by David C. Korten, p. 183. Second edition. Kumarian Press, Bloomfield, Connecticut, 2001.

[2] Ibid, p. 101.

[3] Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das, chapter 21. FT Press, 2011.

[4] In the essay, “Predatory Investment: The Rise of Financial Piracy,” we will see the reason for this important recent development.

[5] The Soul of Capitalism: Opening Paths to a Moral Economy by William Greider, p. 130. Simon & Schuster, New York, 2003.