Why does reckless speculation happen? Is there more to it than just the allure of quick money?
Nowadays, more than 95% of stock returns come from capital appreciation – an increase in the market value of stocks. This wasn’t the case 60 or 70 years ago, when companies paid high dividends, making dividends a significant share of stock returns. Dividends were a decisive factor in investment decisions then, and because of their steady, consistent nature, decision-making was simpler. However, today, as dividends generally make a negligible contribution to overall stock returns, investment decisions are guided solely by expectations of future price changes. The financial system is largely safe and stable, and it works in the general benefit, so long as these expectations are based on underlying fundamentals such as earnings, profitability, economic growth, and interest rates.
Speculation is investing money in assets to profit from anticipated price changes. It is an integral part of modern market-based capitalist society. When investors buy stocks, they are anticipating higher future prices. When a businessperson decides to expand his manufacturing capacity, he is anticipating higher future demand. Speculation works for the overall benefit of society most of the time by helping to find an equilibrium between supply and demand, buyers and sellers, and production and consumption.
However, on certain occasions, speculation becomes reckless, which eventually causes hardship for the system and its participants. It happens when speculation escalates into a frenzy, causing a rapid increase in asset prices that has nothing to do with changes in their underlying fundamentals. Reckless speculation and speculative frenzies mostly occur during periods of high economic optimism, which are simultaneously aided by the cheap, easy availability of capital.
The origin of reckless speculation, on most occasions, can be traced to highly unrealistic expectations induced by an emergent, novel, transformative idea that promises to deliver great progress and, thereby, great profit opportunities for its participants. Forming accurate judgments about new ideas is made difficult by the scarcity of reliable past information about them. With no past to put a leash on, colourful, enticing narratives spread about the emergent idea’s promises, and investor expectations are based on these enticing narratives that seriously lack a factual basis.
Unfortunately, once they fall into the illusory trap of this golden vision, no attempt to make investors aware of how unrealistic and infeasible their expectations are will work. As long as the boom is alive and thriving, any forewarning is seen as evil mongering. People come to their senses only when the boom has ended, prices have crashed, and losses have irrecoverably mounted.
This pattern of excitement, excesses, boom, panic, and bust keeps repeating every few decades despite the existence of detailed written records of several such speculative excesses dating back centuries. Less than a decade separates the 2000 dot-com bubble bust (the result of reckless speculation in internet stocks) and the 2008 global financial crisis (the result of reckless speculation in the housing market). Presently, the progress anticipated from Artificial Intelligence seems to have created a bubble in AI stocks and related industries.
Why do people keep repeating the same mistakes?
The capitalist economy’s unequal reward system is a likely reason. The capitalist system rewards a very small minority of participants exceedingly well. These people become the millionaires and billionaires, while the vast majority struggles to make ends meet. Naturally, this has caused the vast majority of participants to harbour a grudge against the system for the injustice they have suffered. Historically, there were occasions when the vast majority reacted to the skewed treatment through protests, riots, and revolutions. In a way, the rapidly rising asset prices during a speculative frenzy feel to the majority as an opportunity to undo the unequal treatment by offering them promises of large financial rewards in a short time and with less effort. It is the low barrier to entry that makes speculation so enticing. For people left out by the system, for those who failed to capitalise on educational and career opportunities, a speculative frenzy appears as a chance to correct and make up for lost rewards.
Very few are fortunate enough to follow the life path they aspired to when they were young. As they grew up, practical considerations led them to water down their aspirations and instead conform to the capitalist society’s demands. The capitalist society binds its members to itself through its reward system. Many people realise the folly they have fallen for belatedly. Money is what persuaded them to abandon their natural aspirations and conform to the system’s demands. Now, money is going to get them out of the system. Speculation is the path of least resistance; for them, it is the fastest path to riches that would then deliver their freedom and neutralise inequality.
Once people have entered the speculative frenzy, the initial gains from the rapidly rising prices make them feel they are winning. The resulting confidence boost leads them to double down on their bets using leverage – either through credit or derivatives. They are now completely under the spell of the speculative excesses. Booms progress, and bubbles inflate through their ability to attract a regular cohort of greater fools than the previous lot. But there comes a point when all available, willing fools are already being sucked in, thereby slowing the flow of fresh capital that has been fuelling the bubble so far.
The dismantling of the boom and the excesses it created is not too far off now. Episodes of distress and panic follow, interspersed with short intervals of relief. People initially find it hard to comprehend the sharp drop in asset prices. When the bubble finally deflates and the dust settles, the people who aspired to get back through the quick riches promised by the boom are now worse than they were before they entered the frenzy.
What we truly need to stop making the same mistakes is a great upliftment of our collective consciousness. The direct pursuit of wealth is morally corrupting, whatever the motivation. To overwhelm an unjust system, you need to stop playing by its rules, stop catering to its reward and punishment system. By doing so, providence lifts you to a level of awareness where the common good prevails over self-interest. Empathy, compassion, and altruism drive your thoughts and actions. You become more present and mindful. You can feel a psychological richness inside of you, and that is what it means to have a good, interesting life.
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