Objects of hatred - speculation and interest payments

To this day, economic education is virtually non-existent, even among people who learn the principles of financial management. Understanding economic processes at a theoretical or practical level are not at all the same thing.

A famous economist - I think it was Hayek - once said: "I can explain how the economy works, but I am not able to make any money with investments".

Interestingly, Keynes had almost no education in economics, but he had had some success as investor, which falsely led people to believe that he understood economics, clearly a false assumption. Almost everything he said about economics was utter nonsense. One of his worst quotes sounded like a magical invocation: "Inflation can turn stones into bread". No, inflation can do no such thing, but it will prevent the creation of bread by destroying the economy!

In this article, I'll examine the 2 biggest objects of hatred in economics - speculation and interest payments, both topics that will cause lots of moral outrage from a broad spectrum of peole, not just the usal leftists.

Speculators

In my career as independent IT consultant, I worked for numerous different businesses and organizations, often in technical fields, but I also wrote a portfolio management application for professional speculators. I was shocked to find that my clients didn't understand their own role in the economy. Some actually believed their fictional portrayal as "sharks" and even tried to cultivate that image.

They were the most stressed-out people I ever met, constantly swearing and screaming at each other over the phone, with very high rates of mental and physical illnesses. I don't know why anyone would do such a job if it wasn't financially rewarding - because there sure isn't any personal satisfaction in it.

One of my early clients had made a bit over half a million dollars over 1 year while he was a student in Chicago. He used a few hundred dollars out of his allowance every month to buy options. That provided him the capital he used to launch a business in Geneva. I once asked him why he didn't continue working as speculator, considering how profitable it had been. He told me that it had been way too stressful. He once made $60K on one trade, but until the last minute, he thought he was going to lose his entire capital. He actually had a heart attack when he was just over 30 because of business-related stress. He had to seriously reduce his involvement after that.

Despite their bad reputation, speculators have a very important role in the market - they spend their time looking for obvious discrepancies between different markets, preventing the different markets from drifting apart - especially the prices of universally traded goods such as natural resources and food.

Speculators anticipate changes, redirecting capital where it is going to be most needed or recovering badly invested or underused capital. Investors do not cause a rise in prices - they anticipate a rise in prices and they lose almost as often as they win! We only notice those who had winning streaks that made them very wealthy, a bit like looking at a battle field and only noticing the survivors.

Overall, their effect is to smooth out consumer prices and to allocate goods to the highest bidder, which means that scarce resources first go to the most productive use.

Take the example of petrol shortages - which are sadly again an issue, due to Biden's criminal mismanagement, if not outright intentional cooperation with criminals: in the 1970s, quite a few oil companies in Texas were unable to produce more petrol because they could not buy the special lubricant they needed for their operation. They would have been willing to pay a much higher price than anyone else on the market, but the US government prohibited "price gouging", so they could not out-bid all the other users of petrol products, although they could have alleviated the shortage.

Speculators basically see to it that it is the bidder who has the greatest need gets the product first.

A speculator cannot drive up prices unless there is a demand. If a speculator miscalculates and buys a good he expects to rise in price and the demand does not follow, he'll lose money as he will have to re-sell the good at the same or even a lower price, also losing the money he spent on the transaction costs.

If the price rises, it is because the real-world demand actually increased. Once production and demand are in equilibrium, the price will come down - no matter what speculators may do. If the production of a good is sufficient, a speculator will not hold that good to "push up the price", as he'll just lose money - he'd have to keep buying the new supply, which will quickly bankrupt him.

Take the current shortage of electronic goods - car manufacturers cannot produce cars because they can't get the electronic equipment they need. Naturally, these manufacturers would be willing to pay a premium for their parts as halting production is extremely costly for them.

The crypto currency boom led to a massive shortage of graphics cards, which just happen to also be useful for crypto mining. Gamers may be angry about it, but their entertainment has a lower market value than the crypto mining use. Those gamers who have excess resources can get graphics cards from speculators at prices that are significantly above the official market price - a market price that does not reflect the actual demand!

This is what happens when official prices are artificially maintained low - be that for marketing reasons, as is the case for graphics cards, of because of government intervention that imposes maximum prices. Artificial price caps always lead to a massive shortage, as the supply will quicly be bought up and no further investment will increase the supply.

Without the "price gougers" and with artificially low prices, who would get a graphics card would basically be a lottery. Someone who didn't even care much may get one because he had ordered at the right place at the right time. Someone who would value it a lot more would not be able to out-bid him.

If gas prices did not rise based on shortages and high demand, the early buyers might buy as much as they can, thus leaving nothing to those who come after them.

No matter how much speculators may be hated, they will always exist, because they have a very real function niche that will be filled.

Interest payments

Interest payments are also completely misunderstood. Many people still think that interest income is "money for nothing". Quite a few religions decried interest payments as "usury". Islam outright prohibits interest payments. Many Christians think that lending on interest is immoral (and then complain because Jews run many banks; don't get me started on the hypocrisy).

The condemnation of interest or "usury" is based on an archaic conception of economics. In reality, interest payment is a brilliant system to compensate the providers of capital so that they make it available to others. Lending capital is risky, after all. The borrower might go bankrupt or he might die, potentially leading to a partial or complete loss of the capital. And while he lends it out, the capital owner cannot himself make use of it.

Who should get access to capital? And under what conditions?

Without banks that lend at market-based interest rates, getting access to capital can be extremely hard. You might not get any if you can't borrow from friends or family. Or you might have to save up your own capital over a long period of time. This leads to the kind of things I oberved frequently places such as Southern Italy (Calabria/Apulia), one of the poorest areas in Europe: buildings that were unfinished and abandoned or already inhabited, but with unfinished parts, such as a section of the roof or part of a wall missing.

I asked the locals about this and they said that people didn't want or couldn't get mortgages, so they would start building when they thought that they had sufficient capital saved and they ended up running out of money in the middle of the construction:

When a building project has to be abandoned or remains unfinished, that represents a huge cost and loss of capital. It would be far easier if the builder could just have borrowed the capital and then reimbursed the capital with interest.

It is also necessary to put a price on the use of capital, to ensure that it goes to the highest possible social use and is used for production before consumption.

Payment of interest is a system that has a low transaction cost, is straightforward and simple to understand and implement.

Societies that refuse an interest-based capital lending system are stuck in poverty. It was only the availability of interest-based credit that allowed the rapid expansion of the European economy since the industrial age - and we owe that to a large extent to those who did not succumb to archaic beliefs, such as the Scottish, Swiss and Jewish bankers.

Attempts to avoid interest payments based on religious restrictions always lead to inefficient outcomes that are neither just nor rational. Take "Islamic finances": Muslims who try to stick to the Islamic prohibition on interest payments jump through ridiculous hoops to borrow money. The outcome is exactly the same as a very high interest payment, but with numerous added steps.

Here is a typical arrangement based on "Islamic finance": capital owner A gives a credit to B. B sells his house to A. When he re-pays the credit (without interest), he can buy back his house, but at a higher price. The price increase compensates the lender with an income corresponding to very high interest rate. This adds numerous steps, including the real estate transactions with all the added costs and it is only available to people who know someone with a lot of capital.

In short, calling interest payment "usury" is simply absurd. It discredits a brilliant economic system that allows individuals and businesses to get access to large amounts of capital at a predictable cost defined by the market.

Real problems arise when interest rates are no longer market driven. Govenrments intervene far too often, fixing interest rates and inflating the currencies they control.

Example: the Swiss Federal Bank is helping the EU with their disastrous Euro project, which has already destroyed at least 50% of the EU's combined capital. To prevent EU capital owners from bringing their own money to Swiss banks or from placing it in Swiss Francs - in the past a highly stable currency - they started emitting more than 500 billion Swiss Francs (CHF) and used that fresh money to buy Euros, thus driving down the Swiss Franc towards the Euro. They also lowered our interest rates and even forced banks to impose negative rates. Yes, you have to pay interest to keep money in the bank, in Switzerland, which is grotesque!

You can get a mortgage for as little as 0.67%, the latest rate I saw advertised in a newspaper. In other words, you could borrow $2 million and pay just $13'400 for your mortgage or just over $1000 per month to live in a house worth $2 million ($1 is currently worth about 0.90 CHF).

But because interest payments have gone down to such ridiculously low levels, the price of real estate skyrocketed. The same house that went for 1 million 15 years ago now costs 2.5 to 3 million. These were the price changes in 2020 - in the worst regions more than +6%!

Prices only dropped in fairly isolated areas. In Ticino, the southern, Italian-speaking canton, prices probably fell strongly because the border with Italy was closed and the economic activity in Italy dropped sharply.

The actual mortgage payment is pretty much the same as when the mortgage rate was around 3%, but you need 2.5 to 3 times more capital (at least 20%, now often even 25%), which 90% of the people don't have based 

In other words, a higher interest rate helps people get access to capital, while ridiculoulsly low or even zero interest rates make capital inaccessible for the vast majority!

Objecting to interest payments over supposedly moral reasons simply causes economic hardship.

What about "excessive interest rates", e.g. 18% for credit card debt? That's actually a good way to prevent people from over-using capital for frivolous consumption. If people could get capital at a 0.5% interest rate for consumption, we'd have massive over-consumption. Most of the acquired goods would be long gone while people would still pay the - low - interest. More importantly, all that capital would not be available for production. Jobs would disappear, the economic foundation of society would be undermined.

But couldn't government just print more money and hand it out without interest payment at all?

Ah, that's when money becomes meaningless and you get hyperinflation, which leads to the complete destruction of the economy!