15 comments

• Comment Link Friday, 22 July 2011 19:47 posted by Bahadir Aral

  Tracy W
  Your questions’ answers are not in classical economic thinking.
  In classic economic theory there is almost always balance (equilibrium) of supply and demand through pricing mechanism. If there is imbalance, prices goes up or down and in short period of time economy reaches balance again. In that market environment, specualitions are not wrong because if a speculator put money on a land or commodity and price goes up. If price goes up too much, market player realizes situation and increases supply and decreases demand and price goes down over time. Therefore speculator loses money.
  Problem is that classical economic theory doesn’t work in real global economy. Do you know what economic bubble is? Please search it.
  In bubble economics, pricing mechanism is very different and effects of speculations are very different and dangerous too.
  Why would speculators keep holding land if people can’t afford to buy it to use?
  Speculator can still make money by holding the land, as long as the bubble swells. During swelling of the bubble period in bubble economics, new speculators comes in market and brings more money. Therefore price goes up although real buyers can’t afford to buy at that price point. As a result early speculators can still make money by selling the land to late speculators. When the bubble bursts, late speculators who bought land at high price point and still holds it will lose a lot of money.
  In bubble economics, a bubble can continue to swell months, years even decades long, but the bubble can bust in a few days, weeks or months time. That means imbalance (generally overpricing due to speculators) in pricing mechanism is permanent %90 to %95 of time in bubble process (not temporary like in classical economics).
  Moreover when the bubble bursts, not only late speculators lose money, but also it creates a shock in the economy. The economy goes into recession or even worse into depression. Ordinary people who are not involved in this bubble game faces with negative consequences of the shock of the busted bubble.
  Managers of the national economic policy (political and economic leaders) benefit from economic growth created by swelling bubble. On the other hand none of these managers and leader want to face with shock of busted bubble. These managers and leaders prefer decisions which swell bubble and delay bursting. As a result, bubbles continue to swell and become bigger and bigger.
  When bubbles dominate the economy, real buyers who wants the land for productive use must pay premium price and the premium goes to speculators who makes no productive activity. This pricing mechanism slows the real wealth generation in the economy.
• Comment Link Saturday, 23 July 2011 09:05 posted by Tracy W

  Your questions’ answers are not in classical economic thinking.
  
  Nor do I want them to be. The marginalist revolution in economics, displacing the classicals, took place in the 1860s. To be quite frank, I would be incredibly surprised if you were still stuck in classical economics thinking. However, while I am glad to know that you are going to answer my questions with thinking more recent than that of the 1850s, you still haven't actually answered my questions.
  
  To repeat my first question, who do *you* think is selling the CDS swaps? Yes, I am perfectly happy for you to answer this question in a way of thinking more recent than that of the 1850s, and I still want to know what *you* think.
  To repeat my second question: how do *you* think speculators trade currencies off against one another? Yes, I am perfectly happy for you to answer this question in a way of thinking more recent than that of the 1850s, and I still want to know what *you* think.
  You also didn't tell me why you disagree with me about the value that speculators provide when there's a coming shortage of commodities like wheat or oil. Nor did you tell me what you think should happen, in response to such coming shortages, in a politically-ideal world.
  
  Why are you not answering these questions?
  
  The point about the bubble theory I already knew, I mentioned the "greater fool theory" in my first comment. As for your last point: Yes, the buyers who purchase land during a bubble must pay more money and the sellers of the land get more money. Well, what are they going to do with this extra money? Spend it on a shopping spree? In which case the money goes to the retailers and the makers of what they buy, which encourages real wealth generation. Invest it in something non-land related, such as a factory expansion? In which case the money goes into the pockets of the factory owner, the additional employees, the people who supply the factory with its manufacturing goods. Buy more land? In which case there has to be someone who sold the land to them, and they have the extra money to worry about.
• Comment Link Saturday, 23 July 2011 10:00 posted by Tracy W

  Actually, on thinking over it, I'm a bit puzzled here. Just here, you've told me that the answers to my questions are not within classical economics. However, previously you referred me to one of Riccardo's Laws of Rent, that apparently states that land prices always rise (it's not the one I know about). Riccardo died in 1823, didn't he, well before the marginalist revolution, and thus fully within the classical tradition, which you also have told me you can't answer my questions within?
  
  Also, how do you fit the Riccardo's Law of Rent that you described in with your description of bubbles bursting and thus land prices falling? Is your thinking evolving during this exchange?
• Comment Link Sunday, 24 July 2011 09:48 posted by Mark Braund

  Tracey,
  
  I think you mistook Bahadir Adal's repsonse for mine. Responding to you questions as completely as I can given that it's a Sunday, and I don't think you and I are likely to agree however much time we spend on this:
  
  Who do I think is selling CDS swaps? Most of the trade is CDS's is in the secondary market. Sure, they are initailly sold by institutions offering insurance to other institutions making loans and thus exposing themselves to risk. All very sensible. Subsequently, however, CDSs are sold on often and separated from the original risk: this is the difference between CDSs (good) and 'naked' CDSs (bad). And it's why I agree, although I arrived at my conclusions independently, with the expert contributors to File on 4.
  
  Re: RicardoOkay, the law of rent doesn't state that 'the value of land always rises over time' but I believe it indicates why, generally, this is the case.
  
  As for currency speculation: it does make sense to speculate about the relative demand and supply of any two different currencies if your intention is to make gains from that activity. Yes, there is always a buyer and a seller, I accept that sometimes speculators lose out to other speculatoors, but generally, the bigggest losers are those who have no wealth to engage in speculation in the fiirst place.
  
  Re:effective demand versus real demand, especially in the food market: I agree we really need to understand what's going on here. You perhaps think that commodity speculators make a positive contribution to the problem of food production and provision in poor countries. On the basis of much reading, research and experience, I find this not to be the case.
  
  As for how things should be in a politically-perfect economically-ideal world, perhaps you'll allow me to cover this in a future piece?
• Comment Link Monday, 25 July 2011 13:15 posted by Tracy W

  Mark Bruand:
  
  Yes, I did confuse the two people, my apologies to both of you. And that clears up my confusion about what was going on between references to Riccardo and rejection of classical economics. Thank you for taking my mistake so calmly.
  
  Who do I think is selling CDS swaps? Most of the trade is CDS's is in the secondary market. Sure, they are initally sold by institutions offering insurance to other institutions making loans and thus exposing themselves to risk. All very sensible. Subsequently, however, CDSs are sold on often and separated from the original risk: this is the difference between CDSs (good) and 'naked' CDSs (bad).
  
  So you agree with me that for every investor putting themselves in a position to benefit from the sovereign debt default by buying CDSes, there's an investor who has put themselves into a position to lose from the sovereign default? So investors have equally bet against the risk of sovereign default.
  
  Yes, the CDS can be separated from the underlying bond. But still someone must be selling the CDS bonds. And that doesn't change if CDS bonds are sold on the secondary market - secondary markets still require there to be a seller for every buyer. The person who sells the naked CDS on the secondary market is bidding against the likelihood of sovereign default.
  
  As for the benefits of this - let's imagine a smart, and greedy speculator. They bought naked CDSes about two years before the market seriously got worried about the ability of Greece to default on its debt, and Greek bonds start trading at a high discount rate. So at this point, if a default is declared, the speculator manages to make a lot of money. But, if a default isn't declared, the speculator doesn't get anything. Obvious trade now - buy some now very discounted Greek government bonds, so if the Greeks manage to pull it off, then you make a big profit as the bonds become more valuable. So the greedy smart speculator has done two useful things, by increasing the CDS price earlier than otherwise, they've signalled that there's a coming problem with Greece, by buying bonds now when everyone's worried about a default, they raise the demand for Greek bonds and thus they make it easier for the Greek government to raise some more money, meaning the Greeks don't need to cut spending quite as fast in response to the emergency. In other words, speculators who buy naked CDSes smooth out the path to the future. (see See http://ftalphaville.ft.com/blog/2010/03/02/161556/the-benefits-of-naked-cds/ for where I got this from).
  (Note, if you are going to say "I can't agree with this", please do me the kindness of saying why you can't agree.
  
  Re: Ricardo Okay, the law of rent doesn't state that 'the value of land always rises over time' but I believe it indicates why, generally, this is the case.
  
  Thanks for this. But the rise in future rents should be incorporated in current prices anyway, even without speculators. (If you own say a bunch of farmland, and you expect rents paid on that land to rise in the future, you'll only sell the land if you are paid enough to compensate you for the foregone loss in future rents (or, if you *have* to sell for some reason, you should be able to find a buyer who is willing to pay you enough to cover the rise in future rents). So land values should rise at the discount rate if Riccardo's Law of Rent is predicting future increases in rents. Now a change in expectations about future rents can lead to a change in land prices of a different rate, and that can lead to a speculative bubble. But this can happen even with people willing to invest in land, eg I understand the crisis in Ireland has led to a massive hangover of unoccupied new houses, we've seen massive over-investment in things like kiwifruit farms.
  
  As for currency speculation: it does make sense to speculate about the relative demand and supply of any two different currencies if your intention is to make gains from that activity.
  
  Thank you for your willingness to change your mind. I admire that. I'll also note that this interest isn't confined to pure speculators, people who invest abroad or import or export also have an interest in thinking about the future relative demand and supply of any two different currencies.
  
  r, I accept that sometimes speculators lose out to other speculators, but generally, the bigggest losers are those who have no wealth to engage in speculation in the first place.
  
  A surprising assertion as a general statement, what data or logical argument do you base it on? About the only case I can think of where this might be true is when the government tries to intervene and set the currency rate, and winds up losing money on the intervention (where the cost is passed on in the form of higher-taxes and/or less government spending on other services than otherwise).
  
  You perhaps think that commodity speculators make a positive contribution to the problem of food production and provision in poor countries. On the basis of much reading, research and experience, I find this not to be the case.
  
  And famously Adam Smith, living in what was then, by our standards, a very poor country, on the basis of much reading, research and experience decided that commodity speculators made a positive contribution to the problem of food production and provision in poor countries. Would you like to share with us your reasons why you think he was wrong?
  
  As for how things should be in a politically-perfect economically-ideal world, perhaps you'll allow me to cover this in a future piece?
  
  I certainly have no power to make you cover it any earlier. But I am surprised that, as someone who recognises that this topic is not purely academic (as you yourself said, it touches on "the empty feeling in the stomachs of the hungry"), you are unwilling to explain why you reject the assertion, but do find the time to make other, unsupported assertions (eg, "the bigggest losers are those who have no wealth to engage in speculation in the first place".)