Undressing finance #1: speculation
Photo credits: Victor Villanueva
Speculation in the past was (rightly) viewed with very negative connotations. Nowadays, it is common to confound speculation and investment. They are, however, very different even as financialisation blurs the line.
Speculation is to purchase something expecting to make a profit from price movement. So if you “invest” in a house hoping to sell it for much more money in 2 years time, you are not investing: you are speculating (and sustaining the contemporary property boom). On the other hand,you can invest in some lemons that you are going to make lemonade from and sell. That is investment, because you are not holding on to the lemons hoping that you can sell the lemons for more tomorrow. You make a refreshing lemonade from lemons.
Regardless of what people with a better grip on maths than society may say, speculation has no productive or beneficial function.
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So, would your analogy change if lemons were kept whole or are pressed to make juice (lemonade), both for purpose of selling, the proceeds from which will be used to purchase more lemons later?
In other words, does it matter whether lemons purchased are pressed or are kept whole, even though we intend to use the lemons somehow to make purchases at a later date?
But, so the defining difference between speculation and investment, it is in whether one holds on to the item, or resales it straight away, is that it?
Perhaps the analogy wasn’t so clear or the best one to illustrate the difference. Of course I managed to choose an example with perishable goods :p It’s speculation if the motivation is merely a movement in price. I.e. the price of the exact same thing changes
So buying lemons, hoping the price of lemon will go up in the future is speculation. Buying lemonade hoping the price of lemonade will go up in the future. Buying lemons to make lemonade is investment, because you are making a new product — adding sugar, bottling it, etc.
I think it works better with steel as an example. So if you buy steel only to sell steel later it’s speculation. Now, if you buy steel for the production of cars, that’s investing in steel. (I’m not saying investment is always good, I think we are in relative agreement on what happens in the production process). Investment and speculation can be done both in the private sector and in the public sector.
The pre-modern way to speculate was to exploit price differences in different markets (arbitrage) rather than through time.
Speculation — selling the exact same thing somewhere or sometime else profiting on price movement.
Investment — adding economic value by doing something to it.
Of course it is not always as clear cut as that. Consider house-flipping: cosmetic changes are made, but the main driver is booming house prices. I would never consider houseflipping investment.
Of course this conceptualisation is less and less accepted within finance, where there is the stupid notion of investment when there is security of principal and speculation when there isn’t.
Hopefully I’m being clearer ?