There isn't a consensus on the difference between these two, I suspect because speculators don't enjoy the same gravitas that attaches to investors, so all prefer to be seen as investors. Because of this speculators are generally regarded as those who engage in short-term high-risk trading with all others regarded as investors.
I think there is a much more fundamental and important difference, and it is that speculators attempt to profit from price changes in a financial asset, whereas investors profit from its ongoing return in terms of dividends or interest. Speculators buy assets not because they want to keep them, but to sell them later in the hope of a profit. Investors buy assets because they want to keep them. On this view the vast majority of traders are speculators. They have little interest in dividends[229] or interest, except insofar as changes in these payments are reflected in changes in the asset's price.
Warren Buffet must be the best example of an investor. His strategy is to buy and hold, often indefinitely, and he sometimes backs his judgement by buying entire companies. He watches the performance of companies closely, analysing deeply their inherent value - their capacity to generate profits for as long a period as possible. His only interest in price is as a trigger to buy or buy more of a particular stock, his cue being when inherent value is well above the price for which it is offered. He sells stock only very rarely.
Investors are good for the economy. They are like engineers who ensure that the machines in their charge are properly looked after to ensure smooth running, maintained performance and long life. Investors commit for the long term.
Speculators are bad for the economy. They are gamblers, gambling with things that society depends on, and in the process often damage those things, sometimes fatally.
Speculators seek short-term profits, so they buy assets that for whatever reason they believe will rise in price, and sell assets that for whatever reason they believe will fall in price. Buying doesn't normally cause problems in itself, though it can set up the conditions for a later sell-off, it is selling that is potentially harmful. It was mentioned earlier that emotion fuels financial markets (see chapter 57), so that when an asset is subjected to heavy selling, either by a single large holder or by many small holders, other holders see what is happening and also sell for fear of being left with a worthless asset. In this way a cascade of selling can be triggered very easily, and is often started deliberately purely to profit from the drop in price. Short selling is very popular in these situations, when speculators borrow assets in order to sell them, hoping to buy them back later at a much lower price and profit from the difference. A variation on the same theme is also used by market makers[230] who are short of a particular stock - they drop the bid price sharply so as to panic holders into selling for fear of bigger drops to come, and then raise the price again as soon as they have the stock they want. It is known as a 'tree-shake', and is very frustrating for those who were panicked into selling (Burns 2007 pp85-87).
Speculators are gamblers, but the markets they gamble in behave differently to other gambling markets. When bets are placed in horse racing for example it is expected that the bets will alter the odds offered, but they aren't expected to affect a horse's chances of winning the race. But equity market bets do exactly that. The more a company attracts bets (shares are increasingly bought), the higher the share price and the higher the company's value - known as capitalisation. This makes it more secure, enabling it to borrow more and at cheaper rates; enjoy better credit terms from its suppliers; and offer lower prices or better credit terms to its customers. In other words its chance of success improves - if it was a horse it would be more likely to win the race. The opposite happens with selling, and this is a lot more serious. A company that suffers a heavy share price drop finds credit drying up and what credit is available is at higher rates; suppliers won't extend credit, instead demanding payment immediately or in advance; debtors delay payment in the hope of yet further delays if the company is wound up; and customers are asked to pay higher prices or are offered poorer credit terms. In other words its chance of failure rises. If it was a horse it would be more likely to lose the race. This is another example of positive feedback, in this case real company fortunes are tied to the activities of speculators. Speculation distorts the market. In a normal market a company does well or badly as its products are better or worse than similar products from other companies. But with speculation muddying the waters a company does well or badly as speculators, reacting en-masse, buy or sell its shares.
With respect to equities, investors and speculators are the owners of the company, so they do what they can to make management serve their interests. The problem is that investor and speculator interests couldn't be more different. Investors focus on long-term performance, even at the expense of short-term performance, whereas speculators focus on short-term performance, very often at the expense of long-term performance and even of long-term viability. The value to society and the country of a business is its performance over its lifetime - its long-term performance. A country's economy depends on the success of its companies, so anything that damages those companies damages the country's economy, and speculation does exactly that.
The way the market is structured now means that speculators are heavily in the majority, so they are the ones that management serve. Even their own rewards are based on share price (i.e. short-term performance), so inevitably they devote a great deal of time and effort to that single measure. If markets really were rational and efficient, as neoliberals like to believe, the share price would reflect the long-term wealth-creating capacity of the company. But it doesn't, it reflects what buyers and sellers in the marketplace are doing, and fewer and fewer of them base their decisions on a study of the company's long-term prospects as Warren Buffet does - in his case in meticulous detail. Therefore the share price becomes ever more susceptible to manipulation by speculators and especially managers, who have every incentive to postpone or abandon investments or research and development that cost money in the short term but only deliver benefits in the long term, even if without them the future viability of the company is threatened. Similarly they have every incentive to boost short-term performance at the expense of long-term performance, such as cutting back on maintenance, shedding staff and overworking remaining employees, and using creative accounting techniques to defer expenses and bring forward revenues. These things boost the share price, as does using retained earnings to buy back a company's own shares rather than using them for investment in future productivity - a practice that has become very common indeed but is seldom beneficial to the improvement of long-term performance. All this is in spite of everyone knowing full well that maximisation of wealth creation can only be achieved by taking good care of long-term performance.
As an example let's say a company with an average return of 3% on share capital per year can boost its short-term performance up to 5% for a year, but at the expense of long-term performance dropping to 1% for the next ten years, reducing the average performance over 11 years to 1.36%. Investors who knew about the plan would of course be very much against such a boost, but speculators who knew about it would be very much in favour. They would buy shares in order to enjoy the one-year boost, with the intention of selling before the share price dropped to reflect its longer-term return of 1%. Short-term share price boosting happens because speculators know that they can buy and sell rapidly, and the share price rises and falls in relation to short-term performance as a result. You might think that this example is too far-fetched, that no-one, speculators or investors would favour such a scheme, but it often happens as a result of share buybacks. Here a company uses its excess cash not to invest for the future, but to buy its own shares, thereby raising their price. If there are potential investments that the company could make for future benefit then foregoing them improves the share price in the short term at the expense of long-term performance. It is discussed further in chapter 94.
As might be expected banks are heavily involved in all of this activity, speculating on their own account and extending loans to speculators to encourage and amplify their bets, and as a result they tie the whole economic system to speculation. This is what they did in the run-up to the 2008 crash and what they are still doing.
This really is the speculating tail wagging the wealth-creating dog.
When heavy selling occurs real damage can be done. In the case of equities a sudden drop in share price leaves companies very exposed. Everyone that deals with the company fears, quite reasonably, that the company is in financial trouble. Even if there was no basis for the original sell-off the imagined fears of later sellers soon become real in a self-fulfilling prophesy, and the company now finds itself, through no fault of its own, in severe financial trouble. All this can cause a perfectly sound company to go into liquidation because of cash flow problems, or it can become a target for a hostile takeover, when often unscrupulous asset strippers move in to destroy what's left of it to sell the property and other assets at a nice profit. It's all good for the speculators and all bad for the company's employees, customers, suppliers and the economy.
It's one thing for a business to fail because of lack of demand for the wealth it creates, that's market competition working as it should, but quite another thing for it to fail for lack of capital - either because it can't obtain new credit or because interest payments on existing credit take the lion's share of revenue - when product demand is healthy.
Governments can suffer similarly if their bonds or currencies are sold heavily, in which case the economy may collapse when they can no longer borrow money at the interest rates that are on offer and they default on their debts and on paying their employees. Alternatively the IMF may step in with a loan and a host of punishing conditions that make the situation even worse - see chapter 73.
For all these reasons speculation needs to be tamed and controlled, not encouraged as it is under neoliberalism. A Tobin tax has been suggested at various times whereby a small tax is levied on each financial transaction, especially currency transactions, so that the higher the frequency of trading the greater the cost to the speculator. It would help but would only ever increase the cost of trading and perhaps reduce the volume of very high frequency trades; it wouldn't stop speculation, especially when traders sense an opportunity to make a killing. Something much more substantial is needed that favours investors over speculators, because at present both trade on exactly equal terms, whereas investors should be encouraged and speculators discouraged. We don't want to stop speculation completely because it is needed for the secondary market[231] to work - if all investors traded like Warren Buffet it is doubtful that a proper secondary market would exist.
The basic problem is one of inertia mismatch. Wealth-creating companies have high inertia; they can't change their size or direction quickly without damage. When a company needs to change, perhaps because a production facility is obsolete, then it must run down or evolve at a pace that allows time for workers to be redeployed and for materials and property to be transferred to new ownership or be disposed of, or for new technology to be installed and commissioned, teething troubles to be ironed out, and the workforce trained to become familiar with new modes of operation. This can only happen at an appropriate pace if hostile speculative influences can be kept at bay. Speculators and investors are the owners of a company, but only investors take the long view and therefore seek to work in the long-term interests of the company. Speculators seek a quick profit, and don't care one iota whether that is generated by helping or by harming the company. We need a mechanism therefore that makes the movement of shareholder capital reflect the inertia that is inherent in the company and its workforce.
The wealth creation process is subject to considerable inertia, it can't change quickly. Changes in capital allocation need to match the company's inertia in order to allow for properly managed changes to take place. Rapid removal of capital destroys the process and ruins the people engaged in it.
The neoliberal view that capital should be free to move wherever its owners choose and as rapidly as they wish, in the belief that it provides the most efficient and beneficial allocation, completely ignores the dependence between wealth creation and capital. It would be fine if labour, capital equipment and buildings could relocate as quickly as capital can, but of course they can't. The benefits of rapid capital allocation accrue entirely to the capital owners; there is no benefit to genuine wealth creators. Allowing rapid capital movement - effectively without inertia - forces rapid wealth creation change, and the only change that can occur rapidly is destruction, and that is what happens whenever wealth creation is starved of funding.
Recall the money as lubrication analogy (chapter 10): for an engine the lubrication it needs is recognised as an integral part of the engine. If the engine is required to reduce its speed then it is brought down under proper control. No self-respecting engineer would dream of slowing an engine by draining its lubrication. It would certainly be effective - but by causing overheating and seizure, in all probability destroying the engine in the process. This is exactly what rapid draining of capital does to the wealth-creating engine, it destroys it.
Governments and whole economies have considerably more inertia than even the most inertia-intensive companies, so rapid capital movement can be correspondingly more damaging, and should be controlled all the more tightly. We shall see in chapter 73 the extent of damage done to developing countries and their populations by following the neoliberal philosophy, enforced by what Richard Peet calls the 'Unholy Trinity' - the International Monetary Fund, the World Bank and the World Trade Organisation (Peet 2009).
The mechanism we need is one that ties capital more closely to wealth creation, something that increases its inertia in order to make rapid movement more difficult or more disadvantageous to the holder. Better minds than mine will be able to devise appropriate mechanisms once the issue is recognised as a problem to be solved. At the moment it isn't even recognised as a problem so no solutions are on the drawing board. However to start the ball rolling here are some ideas.
For equities, rather than sharing dividends equally between shareholders regardless of how long shares have been held, a time element could be included whereby the longer a share is held the greater the dividend share. That would encourage longer-term shareholding, because the price offered would relate to the share's value to a new holder, whereas its value to a long-term holder would be considerably more. The same principle would apply for new share issues when companies don't intend to offer dividends until much later. Here dividend entitlement would grow with duration of shareholding. This arrangement could also be used to allocate voting rights, giving longer-term investors more say in how companies are managed. Another beneficial effect of this would be to make hostile takeovers much more difficult, because longer-term shareholders would be much less likely to be tempted to sell. This measure would strongly discourage short selling because a shareholder would be most unwilling to lend the share knowing that it would be sold and thereby lose its long-term value.
An alternative might be a much more aggressive Tobin-type tax on share selling. What is required is for buyers of shares to want them for their long-term dividends, not for short-term price gains, so a tax could be levied that diminished over time. Perhaps 50% of the sale price for a share sold in less than a month, 25% for less than six months, 10% for less than a year and so on, with zero tax after five years. That would certainly damp down stock market trading! Of course in all cases people would try to get round the new rules by smart tactics so they would need very careful drafting, including the spelling out of the purpose of the rules, so that any attempts to circumvent them could be outlawed. Speculators could still be accommodated using suitable derivatives, provided that in all cases they were gambling against themselves - like other forms of gambling - without any feedback element to the real value of companies. Also careful watch would be needed for any unintended consequences, which there often are for major changes, and measures put in place to counter them.
If floating exchange rates are retained then similar measures will be needed to restrict currency speculation, but I shall argue in Part 3 that the free movement of capital should be abandoned and floating exchange rates with it.
The major argument in favour of speculation is that it provides liquidity - the ability to sell assets for cash at the market price very quickly. I think this argument is greatly overstated. What is needed is a market; it doesn't have to be a very liquid market. The only people who are really helped by a liquid market are speculators - speculation is good for speculators. Those who want shares for dividends only very rarely need to sell quickly, except in emergencies if they find themselves short of cash, and people should make provision for emergencies without depending on having to sell long-term assets. In those circumstances if they can't find an immediate buyer they can use the shares as collateral for a short-term loan, and sell the shares in due course to pay it off.
In the case of property, speculation is profitable because supply is severely rationed, so an appropriate answer would be to make much more housing available, especially for first-time buyers and the general population. There are always major objections to new house building proposals because they make existing property less valuable. But shortage of housing is damaging individuals and the economy much more than would a loss of value for existing property, so those objections should be overruled. Everyone needs somewhere to live so supply should match demand. At the same time social housing should be greatly expanded to meet demand for rented accommodation at rents that are comfortably affordable.
These matters are considered further in chapter 100.