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function is that of conveying capital into the hands of those best fitted to use it ; of bringing together capital and business power, thereby lowering the cost of production of business undertakings and increasing the national dividend.
The speculator performs important services in both these markets; in the former, for example, he acts in effect as an unpaid underwriter, and may exercise an important influence, sometimes for good, sometimes for evil, upon the direction in which capital is supplied. We are concerned here, however, only with his services in the latter market, the Stock Exchange, considered as an organisation for the continuous redistribution among capitalists of the disutilities involved in the supply of capital outstanding in the hands of entrepreneurs. We need to know, therefore, what is the nature of those disutilities, what is the economy which he effects, and finally whether the payment which he receives for his services is governed by the normal laws which confine the reward of the producer within the value of his contribution to society. The result should indicate the social contribution of the speculator.
The supply price of capital is composite, and consists of three payments corresponding to the three costs or disutilities involved in its supply.
Pure waiting is taken to mean the service of supplying capital for periods terminable at will; its price is the net rate of interest.
The bearing of Risk, or more properly. Uncertainty, needs no description; it is a service which is generally disagreeable, and therefore commands a payment. The third element, the bearing of Financial Insecurity, was discussed by the present writer in an article in THE ECONOMIC JOURNAL in September last; it needs only a brief description here. One of the important circumstances of business is the condition that, owing to uncertainty as to the future, a business man is constantly exposed to the chance of sudden demands being made upon him, and consequently of sudden contractions in the available resources at his disposal which may seriously hamper his operations, and may even result in a bankruptcy, although his assets largely exceed his liabilities. If a business man lends a temporary superfluity of capital on the condition that it is repayable on demand, his position is much the same as though he retained it in gold in his safe. If, however, he supplies capital for longer periods, as on debentures or against a mortgage, his power to meet emergencies is thereby weakened, and there is an increase in his Financial Insecurity, for bearing which he naturally requires to be paid. The bearing of Insecurity
is therefore a real cost in the supply of capital, and the practice of the market shows it to be a service which commands a definite price. Thus “overnight” money is cheaper on the average than the rate on three months bills, and the rate on three months bills which are marketable is lower than the rate on equally secure three month loans, which are not. Every increase in the marketability of a security diminishes the Insecurity borne by the capitalist, for it makes his invested resources more available in the case of emergency. The work of the Stock Exchange in increasing the marketability of securities is therefore, in effect, the service of reducing this element of cost in the supply of capital ; its very great importance is immediately seen when it is realised that, in the absence of this organisation probably only a small fraction of the present supply of capital would be forthcoming for railways and similar undertakings which require the use of capital for long periods of time.
It is usual to include among the costs of production of capital the trouble involved in its administration, but the economies which the market effects in the trouble of dealing in stocks and shares is already estimated in terms of a reduction of financial insecurity, and the other more important part of trouble involved in watching investments is more properly considered as a part of the cost of bearing uncertainty. In considering the social service performed by the market we may avoid separate consideration of its work in reducing trouble, just as, for other reasons, we may neglect the consideration of any effects it may have in reducing the cost of pure waiting. We are therefore left to deal with the costs of the two remaining elements, the bearing of Uncertainty and Insecurity; and we may pass directly to the more limited problem of measuring the contribution of the speculator to the organisation which reduces the amount of these two disutilities by facilitating their rapid redistribution among the group of capitalists in accordance with the changing circumstances of its members; thereby reducing the burden cast upon the capitalist group by the transference of the quantity of capital lodged in the hands of entrepreneurs, or in other words, lowering the cost of production of capital.
The Service of the Speculator.-Commercial operations arise from the profit to be drawn from price differences of two kinds. Differences of price between two points of space call into being organisations for obtaining knowledge of them, and for the transport of goods between the two places. Differences of price between two points of time result in an organisation for forecast
ing them, and for "carrying " goods betwen the present and the future. The two kinds of operation, the trading and the speculative, are essentially similar; they are acts of transport effecting a redistribution of goods, which tends to continue until the interval between prices declines to an amount which just covers the cost of the marginal transaction.
It is therefore quite clear that the direct net social contribution of the railway company and the speculator must be measured by the reduction effected in the cost of carrying goods between persons separated in the one case by space and in the other by time; and that the product arising from this service of transport consists, like that of any other producer, in a utility added to the commodity dealt in; in this case it is a utility of position which is apparent in the form of an increased exchangeability of goods.
The costs of production of this utility, in the case of the speculator, arise, first, from the condition that the carriage of goods through time requires the use of capital, and therefore a charge for interest; and, secondly, from the condition that the essential variability in value of these goods involves a charge for the bearing of Uncertainty. The former element of cost may be taken for granted; the latter indicates the essential service, and leads directly to a consideration of the efficiency of the speculator first in reducing Uncertainty by forecasting changes in value, and secondly in bearing that residue which he is not able to eliminate. It needs to be shown that this service is performed more cheaply by the speculator than by the public.
In order to bring this reasoning nearer to actual business conditions it is convenient to break off the argument at this point, and to trace the effect of the speculator's work in the Stock and Produce Exchanges.
The distinction between the speculative and the non-speculative must be made rather between transactions than between persons ; by a speculative transaction is meant one which is conducted by a person whose operation is influenced mainly by consideration of the future capital value of the security (or other goods) in which he is dealing.
In a produce exchange for, say, cotton, Auctuations in the value of the commodity when regarded over long periods of time, tend to cancel one another. But, although in the long run they may inflict no direct money loss upon the market, the possibility of their occurrence is always an uncertainty to each holder of cotton. The manufacturer who carries his own cotton may in the long run have suffered no direct money loss, but he will have
been continuously subject to imperfectly foreseen changes in his business situation; and he will usually be willing to pay a price for the removal of this evil by buying or selling a future, the price of which will (normally) contain a payment to the speculator for his service in carrying cotton through time. He desires protection against such of these unforeseen changes as arise from fluctuations in the value of cotton, and obtains it by shifting the burden of Uncertainty to the speculative market. Were he not to do so, the Uncertainty to which he would be exposed would require him to maintain a reserve of resources, the loss of interest on which would be a measure of the injury which Uncertainty inflicted upon him.
The holder of a security, on the other hand, is necessarily a bearer of Uncertainty. He cannot separate the Uncertainty from his security and effect a simple transfer to the speculator, though this result may be attained in part by other methods. The security holder desires protection from imperfectly foreseen events which arise from causes external to the market--from those circumstances of his business situation which may cause financial emergency The imperfect availability of his invested resources limits his power to meet emergencies, and therefore carries with it Financial Insecurity. He will therefore be willing to pay a jobber for its removal, and the amount of the jobber's "turn" will depend upon the cost of his speculative service, that is, mainly upon the Uncertainty which he bears during the interval which elapses before he can undo his transaction. It is not, of course, intended to imply that the amount of the jobber's turn (plus the broker's fee) measures the social cost of transferring a security from one investor to another; this amount will generally be a payment for only a part of the process, the remainder being effected by the other speculators in the market.
The work of the jobber appears in the Stock Exchange as an increased facility for marketing ; that of the dealer in the produce market as a bearing of Uncertainty, but although its aspect varies, the same speculative operation underlies both, and its effects are quite symmetrical. The produce broker, by taking over from the manufacturer a burden of Uncertainty, enables him to invest his resources more closely; his costs of production fall, and the gain is shifted to the consumer in a lower price of his product. The jobber in the same way removes Insecurity from the owner of securities; the supply price of capital is lowered, and the cost of production of business undertakings is reduced. The speculative service, fundamentally similar in the two cases, both in its nature
and in its cost of production, effects a cheapening in the process of transport. The saving is shifted to the cotton manufacturer in the form of a reduction in the costs at which he can meet the Uncertainty falling upon him; it is shifted to the security holder in the form of a lower cost of marketing, that is, in the reduction of the burden of the Financial Insecurity to which he is exposed. The economy which the speculator can effect in the costs of transport through time depends, first, upon his ability to bear the Uncertainty of which he relieves others; secondly, upon the extent to which he can reduce its amount by his skill in forecasting the future.
From the conditions obtaining in these highly developed markets, where the speculator's direct service is a competitively produced utility, in effect sold on the market to competent buyers, it is a necessary inference that the gain to the purchaser exceeds the cost to the producer, and accordingly that the supply of the service results in a net social advantage. This conclusion is reinforced by considerations derived from an analysis of the speculator's payment in such conditions.
The Payment of the Speculator.-It is said that a Rothschild laid the foundation of his fortune by a successful speculative transaction; he obtained the earliest news of the victory of Waterloo and reaped an enormous profit by a skilful operation in Consols. His gain may have been a million pounds and his costs £10,000; his service to society consisted in temporarily making Consols rather more marketable, and in raising their price a day or perhaps a few hours earlier than would otherwise have been the case.
It would have been to his advantage to have invested, if necessary, perhaps £800,000 in the organisation of intelligence, yet the advantage to the community would certainly have been no greater; £1,000,000 would have been paid to obtain a trifling improvement in the market. It is evident that the principle of payment here is quite different from that which normally obtains. The speculator's profit is not drawn from the value he contributes to society; it is limited only by a difference of price multiplied by the volume of his transactions. The social advantage of his operation is not measured by this difference; it consists of the additional utility added to the product by the speculative transaction, an amount unrelated to the source of individual gain.
The condition that the gain arises from a difference between two prices does not, however, in itself offer any explanation of the peculiarity, for the profit of a manufacturer or retailer is derived from a similar source ; some further inquiry is necessary.