B (5:27)
And it makes sense that they lose money personally, right? If you, quote, make a bet the commodity prices are going to go a certain way and it blows up in your face, you lose money. You don't want to do that. That's bad for you. And as I'm going to try to argue now here in a minute, I think with standard free market economics at our disposal, we can see it's good for society to minimize people losing money on betting on commodities a certain way. But if they're successful, then that's actually good for society. Okay, so here we go. Let me just take a specific example. Let's say that somebody believes that war is going to break out in Iran. And the, the person's view on that is different from the consensus of the people right now trading in the oil market. Okay. So as I'm recording, this is, it's very possible we'll be at war with Iran imminently. And so in general, when I, when I give this argument and I use the example of a war in the Middle east, it's not possibly at our doorstep, but in any event, we could adapt it to here to say like someone who thinks that the likelihood is even higher than the market consensus is. Okay, and so what would that person do? The person is going to speculate and say, oh, I think right now the market price of oil is not fully reflecting the likelihood in my judgment, that war is going to break out with Iran. They're going to close the Straits of Hormuz. You know, they might fire missiles at other people in the region. In general, shipments of oil from that region of the world are going to be interrupted, to say the least. And so in general, the supply of oil hitting the market is going to be lower over the next six months to a year than what the market currently forecasts. Right? That's what this analyst is thinking. And so what would they do? How do they profit from that view that call a contrarian view, like they're an outlier that they think most people on planet Earth are getting this one wrong or the people who have money that influences the price of oil. And so what would they do? They would invest accordingly. Right. There's all kinds of different ways you could do that. Well, let's, I mean you could buy oil futures, there's other more sophisticated derivatives depending on exactly what their view was. And I'll link to in the Show Notes page here, I've written some stuff for mises.org talking about like the overall case for speculation and then getting real specific about call and put options and then things that are even more sophisticated than that. And so I'll, I'll link to those articles and future zoom forward contracts, stuff like that. Right. So here, for our purposes, I'm not going to get into all the weeds of that, but it, if you really are interested in this stuff and find it, you know, fun to think through these sort of nitpicky little scenarios, it, it's there as deep as you want to go, right? That it's, it's not just, oh, I think oil prices are going to be higher, but like if you think there's a 1% chance oil is going to be above $300 a barrel by next October. There's a way you can invest your funds accordingly on that very narrow prediction, right? Whereas, let's say the rest of the market thinks there's only a 1 in 2000 chance that's going to happen. There's a way you can, you know, bet accordingly, get into sophisticated futures contracts and other sorts of derivatives. All right? But in general, just to keep things fairly simple for our purposes here, you think the price of oil is going to be higher, and so what do you do? You somehow expose yourself to that position. And so in doing that, what are you going to do? You're going to push up the current spot price of oil, Right? Again, the price of oil is what it is right now. You think that's not fully taking into account what's going to happen when war breaks out. You think, make up, run, let's say oil is trading for $70 a barrel right now, and you think it's going to be trading at 200 by the fall, okay? So you go in and load up on positions, and in so doing, you end up pushing up the price of oil to $90 a barrel. Okay? Because you're, you know, you're a small. Maybe even if you're running a big fund or something, you can't move the world price of oil that much. But let's say you move to $20 a barrel. Now, some people would recoil at that and they'd say, oh, you're trying to profit from the deaths of others or you're trying to be a war profiteer. That's, that's despicable. And many governments do pass regulations that like, if a war breaks out and they catch somebody earning unconscionable windfall profits, they tax the heck out of it or just make it illegal. And I think that's the exact opposite of what you want to be doing. And Mises has some great stuff in human action about the economics of war. Right. Mises was not an anarcho capitalist. He thought one of the proper functions of a government was to wage war if necessary. But he didn't think the government should engage in price controls and things like that and wartime profits taxes that he said, no, you want the market economy to be brandished in its full efficiency and power. If you're going to go to war with some other country, and you don't do that by tying its hands, okay? So why would it be socially beneficial? Why do we want people out there pouring over, you know, movements of carrier groups and reading all the different intercepted messages and stuff like that, and going and watching Iranian media and trying to guess, you know, what's going to happen, where the outcomes, you know, what, watching for facial ticks, when the US Negotiators are like being interviewed and talking about, well, here's where things stand right now and just trying to see are they giving us tells in general. You want people out there trying to personally profit from that research? Because let's say they're right, that right now oil is trading, I think the numbers I made up a minute ago, or let's say it's trading for $70 a barrel, but really there's a decent probability it's going to be way higher in a few months. And so what if people who are trading on that push the price up to 90? Why would that be a good thing? Well, because if they're correct, then what happens at the higher price of oil today, before the war has broken out, people respond to that. That has an impact. So just to go over two obvious ones, the consumers of oil, and that would include, like, refineries and things who take it and turn it into gasoline for cars and stuff like that, are going to see a higher price that's going to make gasoline more expensive. And so that's going to make drivers economize on it. And that's actually what we want. Right. And on the flip side, on the production side, the higher spot price is going to increase the amount of oil pumped in the near term and brought to market again, which is exactly what we want. Okay, now what's interesting is there's this mismatch where, you know, in terms of what I just said, that wait a minute, how can it be if, if more oil is being brought to market than was the case, you know, a week before, the speculators all dove in and moved prices with their activity and the end users are consuming less. What's happening in that difference? Right. If more barrels of oil are being brought to market and fewer barrels are being consumed for its normal, you know, industrial consumption purposes, there's this excess that's being, you know, brought to market. And where does that go? Well, ultimately it goes into inventories. Okay, so again, for our episode here, I'm not going to get into all the weeds of this. We could get more specific in some of those articles that I'll link to. I do walk through some of these scenarios, but it depends on the particular assumptions you're making. If the people who are trying to profit happen to own a bunch of warehouses and they just Want to physically stockpile barrels of crude oil, they can do that. So they'll say, oh yeah, we'll come in and buy right now at 70 and just stockpile it and we'll just hold it until the fall, and then we'll sell it at 200. That's one obvious way to do it. In practice, though, they don't have to do that. They can just be buying and selling contracts that then would induce others who don't have a particularly strong view one way or the other that are just responding to the market incentives, and they might stockpile. Okay, so like somebody selling forward contracts that say, I'm going to deliver a barrel of oil to you in the fall if you pay me $150 at that time. And right now, oil's trade at 70. Heck, yeah. Right. So just to make sure, you see, if. If the people who engage in the geopolitical analysis have this very strong view that they're willing to throw millions of dollars at to say, I am firmly convinced that right now the price of oil being 70 is way too low. They can just load up on all kinds of forward contracts and things like that that effectively say, you know, I want you to deliver a barrel of oil to me at $150 in the fall. Because they're thinking we can then just sell that for 200 and make the $50 gain then. So they're sort of locking in that $50 gain in the fall. So given that price structure, that there's people right now willing to buy September oil at $150 a barrel. Because that would be very cheap, right? What? You know, why would they do that? Because that would be a cheap thing to do, you know, that contract. Somebody right now would just say, well, geez, I'll just. Yeah, I could do that. Like the people who right now have the warehouses to store barrels of oil physically. Right. And other types of, you know, depots and reservoirs and stuff, they would go ahead and load up on those contracts, the other side of those contracts and say, sure, we'll do that. And then they would just go and buy the oil right now at 70 and load it up and then just hold it physically. Right. So that's how the thing works. Okay. In terms of why people who have a strong view and are willing to throw money in, it could end up inducing physical changes in the world. Okay. And again, how does that all dovetail? Because is the price of oil right now, the spot price gets bid up to 90. That induces the owners of oil Wells to increase their production if they have spare capacity. Right. Whatever amount they were pumping and bringing to market per week. A month ago, and when the price was $70, the global price. Well, now if the Global price is 90, and from their point of view, nothing fundamental changed, then, yeah, they're going to increase, you know, on the margin to the extent they can. Okay. And so that those extra barrels being brought to surface aren't being burned up in cars. No, they're going into inventory, is. That's getting accumulated. Okay. But now you take a step back and say that's exactly what you want humanity to be doing. If there is going to be this interruption in a few months where oil from the Middle east isn't going to be forthcoming, you would have wanted the rest of the world to be stocking up on their, you know, on their reserves and their stockpiles, inventories, and that's exactly what happens. All right, but the catalyst on all that is you want there to be people out there whose job it is to study the oil market and to try to guess what do I think the price of a barrel of crude oil is going to be in three months, in six months, in nine months, in 24 months, and that they, their activity where they're just trying to make a profit ends up affecting global prices and production and consumption decisions. Right. That's what you want to have happen. Okay, so you can see in that context then, for that particular example, if the government passed a law saying, oh, in the event that war breaks out and the price of oil spikes, anybody who we found had, you know, had large positions in futures and forward contracts and other kinds of derivatives, and now they're going to make a boatload because they bought those things at pennies on the dollar in terms of the par value, and now they're making a huge rate of return on their investment, we're just going to go in and nullify those contracts because we, we got our boys over there dying in a hot war. We can't have the rich fat cats at home getting rich off of this. That's crazy. Right? You could go ahead and do that, but then all that means is going forward, people aren't going to engage in speculation and doing all the research and whatever as much as they otherwise would have, because they know in the event that I'm right and we load up on these forward contracts for oil, then the government's going to come in and cancel it, and then we're not going to, you know, so why would we do that? Because if we're wrong and no war breaks out, then we just lost a bunch of money and the government's not going to come in and make us whole. Right? So it's the kind of thing where if we're wrong, we lose. If we're right, the government comes in and either taxes the heck out of us or nullifies the contract. So why would we do that? Right? And so then you would have the world just chugging along with oil trading at 70, even though there might be a, an actual, you know, high probability that it, it's going to spike. And then when that does happen, if it does, our reserves, our inventory is not as high as it otherwise would have been. And so we're not as able to, to weather that interruption in new supply, you know, hitting the market. Okay, so that's just an example, like I say, with, with oil prices. Okay? So in general, that logic applies to any type of price, especially in the Austrian tradition. Mies, his whole critique of socialism was that the central planners can't engage in economic calculation, even ex post. The planners can't look at the collection of goods and services that was produced and compare it to the resources that went into it and say, did we make a good use of those resources or could we have somehow in a different way use those resources to make a different collection of goods and services that would have been better. Right? And the reason, Mises saying, is because they can't compare revenues and costs. Right? They can't engage in accounting. Right. To know, like any particular factory, were its operations profitable this last quarter or this last year. And so to the old school socialists, that seemed like a completely irrelevant consideration. That was just a vestige of capitalism that really didn't tie into the welfare of society in any way. That was just an arbitrary thing about, oh, the bottom line is just this relic of capitalism that doesn't mean anything. We should care about, you know, getting diapers and baby formula and whatever to poor single mothers and housing for everybody. That's what we should care about. Not was the firm profitable last quarter? But as Mises showed, in order for you to know are we husbanding society's scarce resources efficiently, you need to engage in profit and loss calculation. Okay, so in general then, one way of viewing Mises critique of socialism and his explanation of why the market economy allows for civilization is that it's important to have genuine market prices for the means of production, right? So having accurate market prices is important so that when business people run their profit and loss calculations and they have accurate numbers to Plug in. All right, so that's just kind of in general, if you're familiar with the Austrian school, you should realize having accurate prices is important. Like to know this acre of farmland over here, how should I appraise it? How much should I consider its market value to be when I'm making decisions about what to plant? Right. It's important that that number you plug into your calculation is accurate. All right. So that's why in general, speculators perform a social service. They're socially beneficial if they're profitable. Because again, what it means is a speculator sees an asset that's either undervalued and so they come in and buy, you know, you buy low and sell high. And so that pushes up the price more towards its correct value or they see something that's overvalued. Right. It can happen. The flip side, if a speculator sees something they think is too expensive, right. That they think, oh no, the fundamentals don't support that the market right now is wrong for keeping that price so high in that asset. And so they can short sell it. Right. They can bet against it, if you want to use that terminology. Okay. And again, the sophistication now with derivatives markets allows you to really precisely calibrate how your view differs from the markets. Because it's not just a simple, oh, is that price too high or too low? You can get way more sophisticated than that. Okay, and so why would you want that? If it's overpriced, what happens when the speculator comes in to be successful? You sell high and buy low. Right. And so again, if it's overpriced, you're pushing it down. So with all this stuff, the speculators activity comes in and brings the market price that in some sense is erroneous, more in line with its fundamental value, if you want to talk like that. Right. So successful speculation actually reduces the volatility of market prices. That's another way of viewing it. Okay, and so that in general is good. With, let's take an example with the stock market. So if you are a speculator and you think that there's a particular company out there whose stock is undervalued, what do you do? You go buy it or you do something more sophisticated like you buy call options on it or something. Right. But you do things that ultimately push up the spot price. So again, you're reducing the volatility. Like if you think like, let's say there's some pending lawsuit and most of the people in the market think, oh, the judge is going to throw that out. But, you know, or you believe strongly. No, I've been studying the case, and I think most of the people on Wall street are underestimating, you know, the case that the prosecution has and that or the plaintiff has and that this is. The company's going to lose this judgment. And I bet you it's going to be big, right? And so when that news breaks, that's going to make the stock price of that company tumble. And so why would we want there to be people out there whose job it is to study legal cases like that against big companies and to try to personally profit from their expert view if they think, no, no, no, the market's not digging that stock price enough that, no, there's a, there's a decent chance next week when that verdict comes out, that price is going to fall $30 a share. I don't think the current stock price is adequately reflecting that risk. So I'm gonna come in, I'm gonna short the stock, and what does that do? It pushes the price down now ahead of time. So again, just like with the oil example, where the speculators, in a sense, were pulling forward the future news, right? They were giving humanity more time to react to something that was going to happen in the future. And the same thing here that the successful stock speculator brings forward, whatever it is that's going to happen, if it's the flip side, and they think, oh, yeah, that company's on the verge of announcing this major breakthrough that's gonna make their stock price soar, and so they start trading on that view, that's gonna push up the price now so that when the news is announced formally, the price doesn't jump as much because some of that has already been anticipated. Okay? So that's the way this stuff works. So here again, I'm not gonna dwell too much longer on this. I haven't made the full throat of defense of if you're saying, well, what do I care if the stock price is correct or not? Let me just give you a little bit on that. Because among other things, you know, there's the market for corporate control. Ultimately, the people who own shares of stock in the corporation are the owners of the company. At least if we're talking about, you know, general common stock and stuff like that, with the standard voting rights and such. Okay? So in a sense, when you say, like, oh, how much is that company worth? What you're. Among other things, what you mean is how much would it cost someone to just buy up all the shares of that company, at least at current prices. And then you would have total control. You could even just buy it 51%, of course, and you'd get the majority that way. So for our purposes here, just real quick explanation, why should I care? Well, you could imagine ridiculous scenarios. What if, you know, some major corporation, the stock price was ridiculously low so that you could come in for $100, you could buy the whole company. Well, then somebody could come and buy it. Like somebody could buy a tractor company and just have it making toy, you know, tractors for his kid to play with or something, something ridiculous. And all the valuable assets of that corporation would get devoted to that relatively unimportant use. Okay, so just when you, when you understand Mises critique of socialism and the importance of market prices for economic calculation, you know, one of the things Mises said is, oh, a high price for inputs is the signal to entrepreneurs that, hey, this is a valuable resource. Only use this in your operation if the thing you're making for your customers is very important to them or sufficiently important to them that you're going to get enough revenue from your customers that you can afford to use this input. All right, an example I've used is to say if you're building an apartment complex, if you used a bunch of gold, you know, you had gold plated toilets and countertops and things like that, that would be awesome, right? Other things equal, people would like to live in an apartment that had all sorts of genuine gold that was involved in the design. But the reason you don't see that in practice is that would be ridiculously expensive. And so even though somebody would pay more to live in a two bedroom apartment that had gold furnishings, they wouldn't pay so much more that it would cover the increased cost of building such an apartment. And so that's why gold doesn't flow into apartment buildings. It flows into the hands of jewelers. The people are willing to pay more for gold earrings than for silver or copper earrings. And that's how the jeweler can afford the high price of gold to use in his operations. Whereas the guy building an apartment complex wouldn't dream of using gold in that sense. Okay, so with that background, then, that foundation, let's turn now to insider trading. Everything I just said is still true of insider trading. In general, when you say, do we want people who have knowledge that the market consensus lacks and that they correctly know that existing market prices in some sense are wrong and that they could personally profit from that? In general, do we want them doing it and I think yes, in general we do for all the reasons I just went through, right. That for example, when I earlier was talking about somebody knowing that war is imminent and therefore they're trading on that and pushing up the price of oil and I went through all the reasons that that's socially beneficial, that we want that person doing that to motivate it. I was giving pretty benign examples and saying that they're watching the public interviews of diplomats and stuff looking for facial ticks and whatnot. But I mean in principle there could be, you know, my, everything I said would still be true if instead we tweaked the example and it was somebody who, you know, was, was in those negotiations and then was phoning his brother in law or you know, trying to use some other secure communication to give his brother in law tips about yeah, negotiations here are breaking down. I did, we're not stopping this train. You, you, why don't you go ahead and position yourself accordingly. Right. That the guy's brother in law going, acting on that would still have all the socially beneficial results that I talked about earlier. Right. So in general, that's why I don't think we would want the government out there policing and punishing insider trading per se because another way of looking also it's the arbitrariness of it that what's the difference between insider trading that we think is valid? Because oh no, you're just, it's, you're, you're trading on knowledge that you gleaned because of your, your excellent research abilities and you had an idea to go look at something that other people didn't. Right. We have, I think that's kind of what the general public has in mind when they're like, oh no, we're fine with people going out and doing research on companies and whatever. And like Warren Buffett or somebody, he looks at companies and he says, I think that company's undervalued. I'm going to buy shares of that company and this other company over here, you know, oh no, I don't like that company. We're going to sell that one. We're going to short that people are okay, or at least more people are okay with that kind of thing versus when they say, you know, no, the term is it's not, you know, rare information or contrarian information, it's insider information. The idea is like, no, you have access to information that the general public lacks. And that's why it's supposed to be unfair and say, well, why should someone be able to benefit from that. But again, the issue is not whether the person trading benefits or not. The issue is does it help society if they do that? And again, I think I've argued that it does. And so the specific way the person got access that inside information on that dimension at least is somewhat irrelevant. Right. Like you could argue Einstein discovered equals MC squared and just, it was, you know, unfair there. Other. Most other people were not in a position to discover that. You know, like it's kind of arbitrary to say, you know, could somebody else have, have stumbled upon that? Well, there's a sense in which. Yes and no. Okay, so with all this stuff, yeah. You can come up with scenarios where it's more or less that, oh, it's due to your merit versus the position you were in. But again, notice when I was talking about the price of oil being pushed up and how that would benefit humanity if it were correct, if it really did anticipate what was going to happen, we didn't get into the specifics of how did the person know that that was completely irrelevant. Okay, so now coming full circle. So that's kind of where I was with this stuff. You can see when. Sorry, let me. Before I finish, let me just, let me just try one more on the stocks trading in terms of the winners and losers. That. Let's say there's a stock that's trading at 50. Some guy who's working on the research and development lab at the corporation knows that, oh, next week we're going to announce this new technology that we've perfected. And so he makes a phone call to his cousin and says, you know, I can't do this because it'd be too obvious, but why don't you go and, you know, buy the stock of our company? Because it's going to go up, you know, and it's gonna, they know it's gonna be worth a hundred. And so that guy starts buying it and you know, the word gets out and people are doing that. And so maybe that pushes the price up ahead of the announcement to 70. So I think everybody who's against insider trading is just focusing on, oh, that unfair gain that, you know, those people all are earning, depending on how you quantify the example, anywhere from 50 to $30 of net profit. Right. Cause they're buying in at like 51 up through 70. And then the thing jumps to a hundred, you know, next week when the news is announced. But there's outside beneficiaries too, all the people that they're buying the stock from. Right. The people who had no idea that this announcement was gonna be made that, you know, the stock's trading hands every day if it's a big company. And so everybody else out there would have been buying and selling at 50. And so now if these insiders come in because they know there's going to be this announcement and they push the price up to 70, what happens? Yes, they're benefiting, but the other people who just happen to be selling now, that reduces their, you know, their regret. They get to sell at 70 when without the insiders, they would have sold at 50. Right. And so then a week later, when the price jumps to 100, they would have slapped their heads at, ah, I wish I hadn't sold at 50. But now at least they say, oh, well, I sold at 70. Okay? So it minimizes, you know, their quote loss. Now the other people too, on the flip side, who bought in at 70, they only got the $30 windfall that they didn't know was coming when instead, you know, they could have gotten a 51. But the point is there's nothing meritorious in what they were doing. They didn't know that was coming either. Okay? So again, the idea here is that what the insiders are doing is minimizing the volatility of stock prices, that instead of the price being a 50, 50, 50 and jump into 100, instead it starts rising earlier. And so the, any, you know, the day to day or week to week jumps are reduced. The volatility of stock trading or stock prices is reduced even with just insiders trading on stuff in general. I think that makes the stock market safer for the average investor who doesn't have the inside information. Right. If you're just, you have your funds in a retirement portfolio and there's occasional rebalancing and such, you don't want share prices jumping all over the place. You'd actually prefer is a general rule that insiders, you know, thousands of them in all the different sectors are working all the time making prices less volatile so there aren't sudden jumps that kind of makes it, if you're going to be in the market for 50 years, because that's a portion of your retirement that actually makes it safer for you, less, you know, less volatile. Okay, so that's kind of the idea. And also too, just a quick point, the gains to the inside trader, he like, are less than the losses to society, if you want to put it that way. So his gain there, like, he, if he buys in at 70 and, you know, so he captures that 30, who, who loses out of that, the other buyer, who, who you know, just haphazardly would have randomly bought, not random, but bought that stock at 50 not knowing it was going to go to 100. He only earns 30 instead of 50. Right. So he's hurt, but notice the person who sold benefits. So finally, full circle. I had always said before, there are proposals to ban it for Congress that, don't get me wrong, just because I don't want the government cracking down on this. Individual companies can sign contracts with their employees and vendors and partners and whatever, with stiff consequences for, quote, insider trading, right? So if you're a law firm and you're helping to work on a merger and acquisition deal, you don't want your lawyers going out and profiting from that information because among other things, if your clients know that that's going to happen, they're not going to work with you. Right. Or in general, if you're a company and you're spending millions of dollars on R and D, you don't want your research scientists going out and telling their cousin to go buy this stuff. Right? Because you don't want the information getting out to your competitors and things like that. Right? So you want to keep a tight lid so you can sign contracts with your employees saying, you are forbidden from divulging this. If we catch you doing it, you're fired, we're going to, you know, take your pension, blah, blah, blah. You can do all kinds of stuff like that. And the government, if you're going to say there's a government that enforce contracts, you know, can enforce those things. But the distinction I was making is the government is not there punishing inside information or insider trading per se. It's just enforcing contracts. And then let the companies determine what penalties they might want to inflict on people for personally profiting from knowledge, from the, from the operation. That's the idea. So the. Finally, in that context, it's okay for the US Government to say our employees can't engage in insider trading. Ta da. Okay, thanks for tuning, everybody. See you next time.
