Speculation has become a popular investment practice observed by investors and even business organizations to either earn from profits or hedge and manage risks. However, although it has positive impacts or advantages and benefits, speculation has its share of negative impacts or disadvantages and risks.
The positive effects: Advantages and benefits of speculation
1. Economic benefits
One of the benefits of speculation centers on its positive effects on the economy. It promotes market efficiency because it makes a particular market more liquid or in other words, it expedite the purchase of an asset without causing a drastic change in price. The presence of speculators means that a market has more players and thus, not merely confined to producers and consumers.
Another economic benefit of speculation is production and consumption stimulation. Speculators can increase the demand for a particular asset, thus encouraging production and stabilizing prices. Through the futures market and futures contracts, speculation gives producers advanced earnings from assets they are yet to produce and deliver. The participation of speculators also helps reduce surplus, thus promoting the profitability of producers.
It is interesting to note that speculators are also like insurance companies to a certain extent. They are willing to take risks that others wish to avoid or completely shed. For example, purchasing assets, particularly commodities such as agricultural products or raw materials such as steel, in advance through trading in the futures market can help stabilize market prices by ensuring that producers are financially and operationally sustainable.
2. Individual benefits
The positive impacts of speculation also transcend at the micro and individual levels. Undoubtedly, profitability is the most obvious benefit of speculation. Individual and organizational investors have profited just by selling and reselling assets. This practice has been commonly observed in speculative activities involving the oil and gas market, the stock market, and the foreign exchange markets
Hedging and risk management are other notable benefits of speculation. In markets involving commodities, remember that speculation gives producers or suppliers advanced earnings from commodities they are yet to produce and deliver. Speculators absorb the risks and reward a possibly volatile market, thus giving commodity producers and suppliers an incentive to continue conducting business.
Speculation can also promote the interest of consumers. Because it can stabilize the market and stimulate production, the prices and supplies of relevant assets, specifically commodities, can be maintained at normal levels, thus benefitting end-user consumers such as individuals and even organizations that procure commodities.
When perceived through an organizational lens, speculation allows a business organization to hedge against price and supply volatility, thus allowing them to run their businesses’ more smoothly. For example, an airliner or shipping company can purchase oil in advance and at the current market price under a futures contract based on a speculation that prices can go up in the future.
The negative effects: Disadvantages and risks of speculation
1. Economic risks
One known problem and risk that have been associated with speculation is economic bubbles. Some analysts and studies have tried to explain how speculation can promote market volatility. For example, the subprime mortgage crisis and the 2007-2008 Financial Crisis in the U.S. was attributed to too much speculating in the real estate markets that started in the United States, thus resulting in the housing bubble that created problems in the banking and financial institutions. However, this association remains controversial.
An upward shift in prices is another negative impact of speculation. The oil price shock of 2004 to 2008 was attributed to the decisions and actions of speculators in the oil industry. Some critics argue that speculation leads to an artificial rise in demand while others specifically argue that oil producers and exporters use speculators to indirectly manipulate market price. Similar to economic bubbles, however, there are also counterarguments to these claims.
There is also an argument that speculation is not a value-producing economic activity. Speculators make money without producing products or performing services that are useful to the public. This argument means that speculators are not providing true value to the society in the same way that producers are. Of course, given the positive impacts of speculation in the economy, as well as its benefits that transcend at the micro and individual levels, this claim about the absence of value creation is contestable.
2. Individual risks
Bad investment is another risk and consequence of speculation. Because there are speculators that are drawn to purchasing assets while their prices are low, the demand for such assets increases. However, some or most of these speculators are not really sure when and how the prices of these assets will reach a certain level for profitable reselling. Remember that there are other factors affecting prices and if the price of a particular asset plummets further, there is a tendency for speculators to resell immediately in an attempt to avoid further losses.
In the housing bubble that has been attributed as one of the causes of the 2007-2008 Financial Crisis, speculators bought real estate properties using the money they loaned from banks in hopes that they can resell such assets at a higher price in the future. However, the properties did not appreciate because income remains steady over the years. Some properties were resold at a lower price point. Others were foreclosed by banks because their owners were unable to pay their loans.
The main risk of speculation, particularly the overall practice of speculating in the market, involves the notion that speculators pay little attention to the intrinsic value of an asset and instead focus solely on price movements, the possible monetary benefits they can gain.
It is also worth mentioning that there is a fine line that separates gambling from an investment. In the case of speculation, it is gambling if it is not based on informed decisions. Speculators who bet their money on a particular asset and its future positive price point without research or careful evaluation are more prone to incur losses.
A note on the positive and negative effects of speculation
Speculation and speculators are often perceived negatively due to numerous arguments and claims about their negative impacts, especially the associated disadvantages and risks. In addition, the fact that speculators are out there to make profits from purchasing and reselling seems unappealing for casual observers.
However, given the economic benefits of speculation, as well as its positive impacts affecting the micro and individual levels, it would be illogical to argue that this practice is inherently bad. Possible, speculation can be seen just like any other economic activities that have their susceptibilities toward producing undesirable results. Hence, it is the job of the governments and other relevant stakeholders to manage the negative impacts or the disadvantages and risks of speculations without compromising its advantages and benefits.