Economic Fallacies
The text below originally appeared in 'Economic fallacies Exposed' by Geoffrey Wood. Copyright has been released to the Oxford School of Learning by the Institute of Economic Affairs, to whom we are grateful.
You can download 'Fifty Economic Fallacies Exposed' in a PDF file here [Right Click -> 'Save Target As'].
Read next >>Foreign exchange speculation should be stopped
Attacks on foreign exchange speculators have recently come from, among many others, the US Treasury Secretary and the Labour Party's Shadow Chancellor. It might be thought that there must be something in a view that unites such diverse political standpoints. Not so. All the unanimity shows is the ability for politicians to be wrong together - to display the herdlike mentality of which they accuse speculators.
What is speculation? In the foreign exchange it is selling a currency in the expectation that its value will fall, or buying it expecting its value to rise. Speculation of course can occur in any market - it is just trading in the expectation of making a profit from future price changes. Who dies it? Banks, acting on their own account, and also acting for clients. Their clients can include insurance companies, pension funds and all sorts of commercial firms.
What exactly is wrong with this activity? Note first that if speculators are wrong in their expectations then they lose money. For if, to give an example, they buy a currency expecting its price to rise, and it does not, then they lose at the very least, their transaction costs. So mistaken speculation - speculation whose expectations are falsified - is unlikely to be a persistent problem.
If speculators tend on average to move exchange rates to a 'correct' level why do governments object to them? The answer lies in the meaning of the word 'correct'. They may well be exchange rates which the government do not like - but exchange rates which are the consequence of government policies. Governments often wish to achieve an end , but are unwilling to conduct policy accordingly. In other words, government dislike speculators because speculators expose the weaknesses or the incompetence of governments. Speculators do not 'attack' currencies for fun, on a whim. Most of the time the attack is mounted because politicians' actions are inconsistent with what they say they are trying to do.
By thus exposing governments, speculators not only make money for themselves, they are useful to society. Their actions should be welcomed.
Geoffrey Wood November 1992
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