Daily Speculations

The Web Site of  Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.






Write to us at: (address is not clickable)


The Chairman
Victor Niederhoffer

The Speculator as Hero

This is not a good time for speculators. Last month the FBI and the Chicago U.S. Attorney's office accused more than 100 traders on the Chicago commodities exchanges of systematically cheating investors and the government out of millions of dollars. Lawyers in Chicago have been besieged by floor traders wishing to plead guilty to the charges.

Coming on the heels of the October 1987 stock market crash, popularly thought to be the fault of program traders and portfolio insurers, and amid the popular furor over insider trading, the speculator's stock may be at an all-time low. Even fictional speculators are in trouble. In Tom Wolfe's best seller "Bonfire of the Vanities," bond trader Sherman McCoy is ridiculed by his wife, and is unable to explain what he does for a living to his young daughter. In real life, noted currency trader Andy Krieger, in a widely reported incident in 1987, quit his job after he found himself unable to supply a satisfactory answer to his eight-year-old son's question about what good his job did.

Like Sherman McCoy and Andy Krieger, I am a speculator. I own seats on the Chicago Board of Trade and Chicago Mercantile Exchange. But when my daughters ask me if my job is as important as the butcher's, the doctor's or the scientist's, I answer that the speculator is a hero, and has been throughout history.

Some speculators are discoverers like Christopher Columbus, creators like Henry Ford, or inventors like Thomas Edison. Their job is easy to place on a high plane. My role in the grander order is indirect, relatively invisible and unplanned. The only discoveries I make are the routes that prices will travel. Like hundreds of thousands of other traders, I try to predict the prices of common goods a day or two or a few months in the future. If I think the price of an item will go up, I buy today and sell later. If I think the price is going down, I'll sell at today's higher price. The miracle is that in taking care of ourselves, we speculators somehow ensure that producers all over the world will provide the right quantity and quality of goods at the proper time, without undue waste, and that this meshes with what people want and the money they have available.

Politicians eager to "do something" about high prices often  make laws to punish the speculator. A representative incident occurred during the reign of Emperor Diocletian in Rome in A.D. 300. Speculators were withholding scarce provisions from the hordes, hoping to unload when the demand was even more intense. To remedy this, Diocletian set the highest price for beef, grains, clothing and several hundred other items. Anyone who sold at a higher price would be put to death.

The result? As reported by Lactantius in A.D. 314: "Much blood was shed upon slight and trifling accounts. The people brought no more provisions to the markets, since they could not get a reasonable price for them, and this increased the dearth so much that at last after many had died by it, the law itself was laid aside."

Another representative incident occurred during the siege of Antwerp by the Spanish in 1585. Antwerp was then the leading commercial town of Europe. The Spanish decided to blockade the port to fore surrender when supplies gave out. Knowing this, Antwerp farmer and bakers produced large amounts of bread. Privateers ran the blockade at great peril to provide needed supplies. Prices began to rise. Speculators, guessing that bread was going to be scarce, contributed to further price rises through shrewd purchases.

But Antwerp politicians thought it wrong for greedy speculators to profit from war. The politicians fixed a very low maximum price to everything that could be eaten, and prescribed severe penalties for violators. The consequence was inevitable. privateers stopped running the blockades and the supply of grain dried up. Consumers had no incentive to economize. The citizens ran out of all their provisions after six months of the siege and the Antwerpers starved. They surrendered and were quickly annexed.

Let's consider some of the principles that explain the causes of shortages and surpluses and the role of speculators.

when a harvest is too small to satisfy consumption at its normal rate, speculators come in,  hoping to profit from the scarcity by buying. Their purchases raise the price, thereby checking consumption so that the smaller supply will last longer. Producers encouraged by the high price further lessen the shortage by growing or importing to reduce the shortage. On the other side, when the price is higher than the speculators think the facts warrant, they sell. This reduces prices, encouaraging consumption and exports and helping to reduce the surplus.

Of course, speculators aren't always correct. When they are wrong, their actions contribute to shortages or gluts. Manias such as the Tulipmania, the South Sea Bubble, the Mississippi Bubble, gold panics, stock market crashes, and violent swings in the value of the dollar are frequently cited as examples of occasions when speculators contributed to instability and imbalance. But who could do the job better?

Bureaucrats have little incentive to improve, invest or innovate. When speculators are wrong, however, they are punished severely for their mistakes by losses of their own money. If left unchecked, the tendencies of our modern kings to interfere with the natural working of the marketplace would lead to destruction. But speculators, searching for profit, send signals to producers and consumers as to the forces of destruction and good.

Traders sent such a signal on October 19, 1987, when they dropped the wealth of the non-Japanese-speaking world by 10% in one day when a modern-day king tried to interfere with the natural order by driving the dollar down one last 5% or so.

Perhaps the most positive impact of our current-day speculators is to check at inception governmental activities that would have an inflationary impact. Governments are prone to spend more money on their activities than they take in through taxes. The consequence often has been substantial inflation, followed by war, revolution and destruction of civilization. Nowadays, however, bond traders are so alert to the long-term consequences of such activities that they immediately send debt yields up significantly at the first sign of inflation.

The increased yields have such a negative and immediate impact on government revenue, business activity, and consumer spending that governments have all but given up trying to sneak increased spending past the market. As a result, the rate of inflation slowed markedly throughout the Western world during the 1980s. At the end of last year the long-term yield on a 30-year U.S. Treasury bond was 8.8% vs. 14.4% on the day after President Reagan was first elected. The great era of prosperity that has accompanied this reduced inflation adds a feather to the speculator's cap.

Granted, speculators are not angels; many are motivated by gambling and greed, and when given the chance will take advantage of the public as much as the next person.

What is the net effect of such evilness? Consider the purchase of one Treasury bond futures contract, the most actively traded futures contract. This is where the U.S. Attorney apparently focused his investigation after the undercover agents suffered huge losses for the government's account in stock market futures during the October 1987 crash.

To buy the equivalent of $100,000 in bonds, an average customer might pay $17.50 in commission (half of a typical $35 commission for one contract's purchase and sale) and $31.25 (one "tick"), the usual spread between the bid price and the ask price. This adds up to a $48.75 transaction cost for each $100,000 purchase.

Compare this with the "gentlemanly" New York Stock Exchange, where market-making speculators have a monopoly on trading in individual stocks. To purchase $100,000 of IBM stock (about 800 shares), the most actively traded Big Board issue, an average customer might pay 40 cents a share in commission costs and a 25-cent-a-share bid-ask spread. This $520 transaction cost is more than 10 times the cost to trade the same dollar amount of futures contracts.

Much of the suspected wrongdoing in Chicago apparently involved unscrupulous futures brokers who misreported customer transactions or gave customers unfavorable prices. But even if a bond-futures broker, for example, stole an additional $31.25 tick on every customer order, if the liquidity of the market would still be far greater than that of the less-competitive Big Board. The customer would still be paying only one-sixth of the cost of the same trade in IBM stock.

This example serves not to exonerate crooked futures brokers, but to demonstrate the efficiency of a competitive market. Despite the overwhelming evidence that the speculator gets the job done, governments have attempted to bypass speculators in the name of a higher good.

The intellectual raises his eyebrows at the economic and historical analysis and contemptuously says, "Man cannot live by bread alone." To this I respond that without us, there would be no bread.

I am proud to be a speculator. I am proud that my humble attempts to predict Tuesday's prices on Monday are an indispensable component of our society. By buying low and selling high, I create harmony and freedom.

Mr. Niederhoffer is chairman of NCZ Commodities. This article appeared in the February 10, 1989, issue of The Wall Street Journal. Dow Jones and Co., Inc., 1989.