dumping as a kind that "does not develop continuous business." (Testi-
mony of the government suit against the Steel Corporation. 1913, x, p. 3843.)
PROTECTION AND FREE TRADE 305
been said that figures will prove anything. If the
principles of statistical science are followed out this
statement is not true, but an unscientific use of statistics
will often bolster up an argument which is really
untenable.
CHAPTER XXIII
INVESTMENT AND SPECULATION
The Flow of Capital We have already had occa-
sion to refer to the flow of capital. This must now
be considered a little more fully. Our definition of
the term included " that form of wealth which is
used for the production of more wealth." This
definition is unaffected by the ownership of the capital.
The owner of wealth who desires to use it for the pro-
duction of more wealth does not necessarily have to
employ the capital himself. He may lend it, for a
consideration, to others who will use it in their business.
The transfer of the capital from the owner to the
user does not alter its character.
We may take it as a fundamental fact that, other
things being equal, the owner of the capital desires
to obtain the greatest return possible from its use.
The limitation is important, for the element of the
safety of the capital is one which deserves careful
consideration. Of two methods of using capital,
both of which are equally safe, that one will be chosen
which promises the greater return. Hence capital
which is employed in a business which does not lend
itself to the earning of the largest returns consistent
with safety is always liable to be transferred to another
industry or occupation where the profits are higher.
This is only true, however, of liquid capital. Fixed
306
INVESTMENT AND SPECULATION 307
capital cannot be easily transferred. It is not true,
for instance, that because the automobile industry
promises greater returns to capital than the cotton
industry, cotton factories will therefore be turned
into automobile plants. On the other hand, a firm
which has been engaged in manufacturing bicycles
may realize that greater profits could be obtained
by making motor cycles and may comparatively easily
adapt its machinery to such production. This is
possible only where the fixed capital employed in the
old business is capable of being used in the manufacture
of the new product with comparatively little change.
How then does capital flow from one industry to
another ?
Investment There is always a certain amount of
what is known as liquid capital seeking employment.
This capital is always represented by money or the
equivalent of money. That is to say, it is not fixed
capital. It may be converted into fixed capital, of
course, for money and its equivalents imply a com-
mand of fixed capital. This money is open for invest-
ment. That is to say, the owners are not, as a rule,
desirous of using the capital themselves. They are
willing that others should use it, provided they receive
a share in the profits resultant from its use.
Merchants and manufacturers who do not themselves
possess sufficient capital for their own requirements,
and who could use more with satisfactory results,
invite the owners of idle capital to lend them their
funds, or to " invest them in the business." The
investors do not necessarily lose control of their capital.
In most cases the fact that they have invested funds
308 AN INTRODUCTION TO ECONOMICS
in a business gives them the right to a say in the man-
agement of the business, proportionately to the amount
invested. Apart from this fact, however, they are
always at liberty to sell their holdings to others, if
they can find purchasers. In this way the fixed
capital remains with the business. All that changes
is the ownership.
The profits resulting from the employment of capital
may be used in two ways. Either they may be used
for the purchase of consumption goods; that is, goods
to be used in the satisfaction of ultimate wants, or
they may be invested in business. With the former
use we are not at present concerned. The latter,
however, is the method by which the flow of capital
is secured.
As we have said, capital flows toward those occupa-
tions which provide the greatest returns, other things
being equal. There is always a point at which capital
will cease to be employed in any business. That
is the point at which the profits are not sufficient to
provide more than the necessary expenses of opera-
tion. This statement, in practice, requires a cer-
tain modification. Investors do not always look to
immediate results. It is quite possible for capital
to be attracted toward an industry or business which
at the moment is not earning profits. In these cases,
however, the investors hope that the future profits
will be such as to offset the temporary lack of earnings.
But in the ordinary case where a business has ceased
to earn profits in excess of the operating expense,
those who have invested their funds in the business
will endeavor to sell their holdings even at a loss,
INVESTMENT AND SPECULATION 309
in order that they may invest the proceeds in some
business that is actually earning profits. They realize
that it is better to earn a profit on a small investment
than nothing on a large one. The buyer of the shares
justifies himself with the belief either that the business
is likely to improve, or that in liquidation he will
receive a sum greater than that paid for the shares.
Usually it is the former which decides the purchase.
Occasionally, also, the holder of an investment desires
to use his funds for the purchase of consumers' goods,
in which case, all that happens is that the ownership
of the investment changes hands.
Par and Investment Price In the buying and
selling of invested capital there is a great deal of price
fluctuation. Leaving out of consideration, for the
present, fluctuations due to speculative causes, the
changes in price are primarily due to changes in
the earning power of the business. Following out the
laws of supply and demand, which we have already
studied, there is a tendency for the returns to the
investment to be averaged fairly evenly. Given
equality of security, for instance, we may say with a
fair degree of accuracy, that the returns to one invest-
ment will tend to equal those from another of the same
amount. To illustrate this, let us suppose that by
investing $1000 in a certain business a return of 4
per cent is secured. Let us suppose that the average
rate of interest is 5 per cent. No person who buys
the investment of $1000 from the original investor
will give $1000 in payment. His reasoning is simple.
By investing $1000 at the average rate he can obtain
5 per cent. Why, therefore, should he pay for an
310 AN INTRODUCTION TO ECONOMICS
investment which will only yield 4 per cent? He
offers, let us say, $800. If the sale is made, then the
new holder of the investment receives as interest on
his shares 4 per cent on the original $1000, or $40. But
as he only paid $800 for the investment, the actual
amount earned on that $800 is equal to a rate of 5
per cent, the average rate.
If, on the other hand, the average rate of interest is
3 per cent, the holder of the original $1000 shares
will not sell at par, or face value. If he did, and then
tried to invest the $1000 again, he would only gain
3 per cent instead of four. He demands a higher
price and the sale is made at about $1300, which
gives a rate of approximately 3 per cent to the pur-
chaser. When shares are sold at their face value,
they are said to be at par; when sold at less than
par value, they are sold at a discount, and when sold
at more than par, they are at a premium. Shares,
therefore, tend to be at a premium when the rate
earned is greater than the average rate and at a dis-
count when it is less than the average rate.
The Future Element in Business This is simple
enough to understand if we consider the price as being
entirely determined by the present earning capacity of
the business. But the investment market is very
easily influenced by hopes and fears. In fact it would
be almost safe to say that the hopes and fears have a
greater influence on the market than present conditions.
Now the causes which produce and influence these
hopes and fears are innumerable. Hence there is a
constant fluctuation in the value of investments.
The future element in business is not confined to
INVESTMENT AND SPECULATION 311
stock and share investments, however. In every
aspect of business the future is to a certain extent
discounted. The prices of commodities are affected by
the prospects of increase or decrease in the supply, a
possible scarcity in the future leading to a holding of
stocks for the future market, thus raising prices in
the present market by reducing the effective supply,
and reducing future prices by increasing the future
supply.
Speculation It is the future element in business
which gives rise to speculation. There is hardly any
more controversial subject than the question of the
values and evils of speculation. In order that we may
examine this question in a satisfactory manner we
must be quite clear as to the meaning of the term.
Like many others, it is used with great laxity of mean-
ing, and without careful definition no argument is
possible.
In every meaning which is attached to the term
speculation, there is one common element, that of
future uncertainty. The greater this uncertainty,
the greater is the speculative element. But future
uncertainty is ever present in life, and business is
peculiarly subject to it. Any man who undertakes
to supply some of the needs of the community runs
the risk of misjudging those needs, or of not being
able to satisfy them at a price remunerative to him-
self. He runs the risk of being forced out of business
by competition, by inability to do the work properly,
by lack of capital, by failure in the supply of raw ma-
terials, by convulsions of nature which destroy the
economic value of his situation, by the vagaries of the
312 AN INTRODUCTION TO ECONOMICS
weather, and so on to infinity. Any man who wishes to
enter business and avoid these risks is asking the
impossible. In so far as he accepts these risks he is
speculating. That is, he is taking a chance that his
future profits will not be seriously interfered with
by these possible future dangers.
No one will attempt to deny that this sort of specu-
lation, the risking of the inevitable dangers of com-
mercial life, is justifiable. It has its evils, no doubt,
but these evils are inherent in commercial life and
cannot be avoided. No one has any respect for him
who wraps his talent in a napkin and buries it.
But these inevitable risks are minimized to the
greatest possible extent by the wise business man.
A good farmer does not plant his seed without consid-
ering first the possibility of getting the crops to market.
The banker does not invest the capital of a metro-
politan bank in a little country town. Still, no matter
how great the care taken, losses are bound to occur.
All that can be done is to minimize the losses and
spread them over as large an area as possible so that
the blow to the individual will be lightened.
In many discussions of speculation great stress is
laid upon the form which we have just described.
But the discussions lack life, for the common use of
the term practically ignores that form of its application.
Stock and Share Investment We have already
seen that in the sale and purchase of stocks and bonds
we have the mechanism for the flow of capital. Assum-
ing the existence of the free play of competition in an
open market, the rate of profit on industry is determined
by the ability displayed by the manufacturer or mer-
INVESTMENT AND SPECULATION 313
chant in satisfying the demands of the community,
or by special circumstances which give him a peculiar
advantage in producing the goods or services required.
Loss occurs when the demand of the community
does not exist or is not of sufficient strength to justify
the amount produced. Hence the flow of capital
tends to insure that those services which are desired
by the community attract the necessary amount of
capital to cause their production.
The owner of capital which is free for investment
must keep a keen watch upon the growing needs of
the community. If his judgment shows him that a
particular commodity or service is likely in the future
to be in greater demand by the community, he takes
prompt advantage of that judgment to invest his
capital in the production of that commodity or service
so that he may reap the profit bound to be realized
as the public demand grows. He may be said to
render a public service in that he anticipates the need
of the community and provides satisfactions for its
desires as soon as they arise.
It may be, of course, that his judgment is in error,
and he reaps the fruits of that error by unnecessarily
increasing a supply and consequently decreasing the
price of some commodity. The result is a loss, not
only to him but to other producers who were first
in the market. If we assume that, on the whole, he
is' correct in his anticipations, then he prevents the
sudden rise in prices consequent upon a sudden increase
in demand with a constant or decreasing supply.
To make this more clear, let us take an illustration.
Let us suppose that a certain investor foresees that,
314 AN INTRODUCTION TO ECONOMICS
owing to the discovery of some new method of pro-
viding the generating force for electricity there is
likely to be a great increase in its use. The result
will be a considerable increase in the demand for
copper, rubber, etc., for conductors and insulators.
He invests his capital in the production of copper
and to that extent increases the supply of copper.
As the demand for copper materializes the supply
is shown to be more nearly adequate to the demand
than would otherwise have been the case, and while
there may still be an increase in price, the increase
is not so great as it would have been had there been
no increase in the supply. The public is, therefore,
able to reap the benefit from increased use of electric-
ity without having to pay an unduly high price for
copper.
The cases referred to above, however, only refer
to speculative investments and not to pure speculation.
If all speculations were carried on with the idea of
reaping profits through the intelligent anticipation
of the future needs of the public, there would be little
criticism. Moreover, there would be no desire to
juggle with the prices of stocks and bonds. But a
vast amount of speculation has no real relation to
the investment of capital. The speculators do not
invest; they merely play with the rises and falls in
prices of different securities. This amounts to mere
gambling and in spite of a certain amount of specious
arguing to the contrary, there can be no economic
justification of these operations.
The Method of Stock Exchange Speculation In
order to understand this matter better, let us consider
INVESTMENT AND SPECULATION 315
the methods of the stock exchange speculator. Sup-
pose he has a capital of $20,000 with which to operate.
He decides that a certain stock, let us say, Montana
Copper, is due to rise in price. His reasons for think-
ing this copper company's stock will go up may be
due to careful consideration of the copper market,
or they may be due to " inside information " that a
bigger than usual dividend is to be declared; or he
may hear that some big operator is planning to get
a controlling interest in the mine, or any other of a
multitude of reasons. Whatever they are, however,
he decides to buy. He places an order with his broker
to buy a thousand shares at the market price which
is, let us suppose, 110. This would appear to call
for a capital of at least $110,000, which is more than
he possesses. He does not pay for the stock himself,
however, he merely " puts up a margin " of ten points.
That is he pays about ten per cent of the price to his
broker. The broker on the strength of the deposit
of securities with the bank obtains a call loan for the
balance. The actual amount which the speculator
has paid the broker is $11,000. Now if the shares
go up in price to 120 and at that figure the speculator
thinks they will stay, he sells out. The broker, there-
fore, pays to him the difference between the price at
which he bought and the price at which he sold the
shares, together with his margin, deducting the usual
commissions.
Our speculator, therefore, has received from the
broker approximately $22,000, making a profit of over
$10,000. If the stock had gone down instead of up,
the broker would have asked the speculator to support
316 AN INTRODUCTION TO ECONOMICS
his margins. The broker requires a ten-point margin.
As the stock goes down in price the broker knows
that he will receive less than he paid for it if he sells.
As long as the difference between the purchase and
selling prices is less than the amount deposited by
the speculator the broker is safe, for by selling the
stock he gets the bulk of the price back and the dif-
ference he makes good by drawing on the deposited
margin. If the stock falls ten points instead of rising,
the speculator may still keep the stock by paying
additional amounts to the broker. The further it
falls, however, the more he has to pay in and there
comes a time when he can pay no more. The broker
sells the stock " at the market " and the difference
is made good out of the speculator's margins.
It will be noticed that this speculation has not
helped the industry in the slightest. In fact there
has been no investment at all by the speculator. He
has never actually held the stock at all. The stock
has really been held by the bank which made the
call loan. The speculator has merely made a bet
that the stock would rise. If he wins the bet, he
profits. If he loses, some one else profits. In any
case it is practically certain that he never sees the
stock he is dealing in.
The case is still clearer when the speculator is sell-
ing " short." He may believe that a certain stock,
of which he has none, is likely to fall. He orders his
broker to sell that stock, and relies upon being able
to buy stock at a lower price in order to deliver it to
the person to whom his broker originally sold the
stock. If the stock goes up instead of down, he must
INVESTMENT AND SPECULATION 317
still buy it in order to make delivery to his purchaser.
He buys therefore, at a higher price than that at
which he sold and so loses on the transaction. Again
there is no investment, for he sells before he owns
the stock and as soon as he does own any he transfers
it to his original purchaser.
Grain and Produce Speculation The same meth-
ods are used in the speculation in grain and other
produce. Men who would not know the difference
between wheat and barley if they saw the two together
may speculate on the crop markets. Crops are bought
and sold before the seed is planted and the total amount
of transactions probably far exceeds the total value
of the crop when it is actually reaped.
Speculation and the Stability of Prices Theoreti-
cally it is often argued that the speculation in futures
tends toward stabilizing prices, that is, preventing
the extension of the price fluctuations. The argument
is simple enough we have already outlined it in
regard to investment. If prices are high at present
and the speculators believe that they will fall, they
sell. But the fact that they sell now tends to lower
the price. As soon as the price seems likely to increase
they buy, thus helping the price to rise. But as they
prevent a high price from going higher and a low price
from going lower, they are therefore helping to keep
prices level. This argument is not true to the facts,
however, for it is seldom that a speculator sells in a
market which is rising. He usually " follows the
market." If he sees prices falling, he acts on the
opinion that they will fall farther and hence helps
them to fall. If they rise he seems to believe that
318 AN INTRODUCTION TO ECONOMICS
they will rise farther and so he buys, thus helping the
price to climb.
As a matter of fact, there cannot be the slightest
doubt in practice that, far from helping to stabilize
prices, speculation tends to increase the fluctuation,
even when it does not do so deliberately.
In the stock market the prices that are paid for
stock often have not the remotest connection with
the actual value of the stock. For example, we may
cite the price of Northern Pacific stock which went
as high as $1000 for the $100 share during the fight
between James J. Hill and E. H. Harriman for control
of the road. This price was absolutely unconnected
with the actual value of the shares in that railroad
company. Again in the famous Boston gas war,
the prices of shares had no relation to the normal
value of the stock of the various companies concerned.
Psychological factors are of immense importance
in the stock market. A stockholder may be thor-
oughly convinced that his stock is worth what he
paid for it. But let him see continuous heavy sales
at lower and lower prices and he will feel more and
more uncertain. As the prices fall he will gradually
feel that he must realize on his holding at once lest
their value disappear. This psychological factor is
realized by the stock manipulators and it is, unfor-
tunately, no uncommon thing for a valuable stock to
be " beared " so that the " bears " may afterwards
buy it in at a small price.
Control of Speculation The control of speculation
is extraordinarily difficult. It is admitted that the
genuine purchase and sale of stocks is valuable as
INVESTMENT AND SPECULATION 319
society is organized at present. But there is no differ-
ence in technique between a genuine sale and pur-
chase and a speculative one. Hence schemes which
would effectually control speculation at the same time
control investment. The stock exchange has rules
which must be observed by its members. But there are
always the curb brokers and there are ways of break-
ing the rules without appearing to do so. We have
no space to go into the technique further. The ques-
tion of the control and regulation of stock exchange
gambling is one which must receive careful attention
by the public and its representatives in Congress.
CHAPTER XXIV
RENT, INTEREST, AND PROFITS
Distribution as an Economic Problem Much
of our previous discussion has been concerned with
the problems of production and exchange. We must
now turn to another element in economic life the
distribution of the products. This problem is not
to be confused with the difficulty of mechanical trans-
portation. The word distribution is used in another
sense. When goods have been produced there always
arises the question as to the ownership of the goods.
When work has been done there arises the question
as to the price to be paid for the labor. If we consider
labor merely as a peculiar form of goods, then, of
course, we can deal with it under the general laws
of exchange which have already been discussed. We
shall see, however, that labor, or rather, laborers
refuse to allow themselves to be considered in that
manner nowadays. Indeed it is not only the laborers
who refuse. Governments also, in every civilized
country, take certain steps to prevent labor from being
so regarded. Let us put the problem concretely.
Suppose a factory turns out goods which are sold for
one million dollars. Suppose further that the cost
of the materials from which those goods were made
amounted to $250,000. How is the balance to be
divided ?
320
RENT, INTEREST, AND 'PROFITS 321
Now in any ordinary concrete case it is simple to
enumerate the different recipients. In the first place
the laborers (including within the term those who work
by brain as well as hand workers) must receive a cer-
tain share. Those who supply the capital require
a certain amount for the loan. Those who provide
the land and buildings upon and in which the goods
are made must receive their payment. If anything
is left we may provisionally regard it as profits.
This is one aspect in which the problem of distribu-
tion may be regarded. It is impersonal, for we are
merely trying to divide the proceeds into the ratios
suitable to the value of the different factors in pro-
duction land, labor, and capital. There is another
aspect, however, which is of considerable, if not of
paramount, importance. One of the greatest problems