TCS Daily

It's Fair to Speculate

By Christopher Lingle - July 1, 2004 12:00 AM

A bubble in real estate in some of South Korea's larger urban areas has resulted in some poor economic analysis and worse policy recommendations. For example, large and continued increases in property prices have been blamed on speculators that have become demonized.

In fact, it is more appropriate to blame the central bank for pumping excessive liquidity and credit into the market. Without easy credit on the back of artificially low interest rates, price rises in one sector of the economy would have to be offset by price declines in other sectors.

But let's look at the attempts to curb speculation in apartments that is meant to stabilize consumer prices and discourage wealthy people from making large unearned income. According to a government plan, multiple property owners will face larger tax burdens in the near future. A new comprehensive tax system would target people with high-priced properties or those owning multiple lands or apartments in two or more areas.

These actions should be seen for what they are: an attempt by politicians to grab more tax revenues by creating a bogeyman. It is also an attempt to deflect blame from the fact that budget deficits and loose credit policies have fueled the property bubble.

The image of a greedy speculator that earns much while doing little is erroneous and misleading. It turns out that speculators actually have a positive effect on markets since their actions tend to stabilize prices over the long run. As it is, anyone who tries to buy low and sell high is a speculator. Indeed, anyone serving as a middleman between buyers and sellers is speculating that they will earn more from one than they pay the other.

But there is some special dread and loathing of property and currency speculators. Somehow they are attributed with some magical power to influence the expectations and actions of other market participants. However, it is important to be clear that speculator try to anticipate price movements that are going to take place rather than initiating or causing them. Those that speculate hope to anticipate what other people will do and try to do it before they do.

When a buying spree is anticipated, they will buy as quickly as possible. And if a selling spree is expected, they will sell now. Then they will then sell what was bought before the buying spree is exhausted while buying back what was sold before the selling spree is exhausted. If they make correct predictions and move in due time, speculators will make money. Likewise, they will lose money when they are wrong or move too slowly.

But more important is that successful speculators' actions will have a smoothing effect on price swings that would have taken place without their actions. Markets with active and successful speculators tend to be less volatile than otherwise.

This is because actions by speculators smooth out supply and demand over time and tend to moderate price swings. Speculators are guided by profit maximization and seek opportunities to buy at a low price before re-selling at a higher price. Since low prices indicate that a good or service is abundantly available, a purchase by a speculator helps suppliers by setting a floor on prices. Likewise, higher prices indicate greater relative scarcity so that when speculators sell their holding they aid buyers by moderating price rises since more is made available.

Of course, making wrong guesses or action may exacerbate price swings and destabilize market conditions. But those that lose often will see their funds wiped out and they will no longer be a factor. It seems that the misguided campaign against speculators has also provoked a wave of xenophobia in that foreigners are blamed for some of the price rises in local real estate. If local property and currency speculators are bad; then foreign ones are worse!

It is true that foreign property investment funds made purchases at distressed prices after the turmoil of 1997-98. These included land worth over 18 trillion won and buildings worth about 3 trillion won. But foreign buyers should not be viewed differently in that they set revenue targets when purchasing real estate or other assets that are sold when their goals are reached.

While curbing speculation is wrong generally, it definitely should not be used as an excuse to treat foreigners differently from locals. Cross-border investments are normally viewed as benign or beneficial, especially when involving purchase of productive facilities. And when foreign investors earn capital gains on assets, they pay taxes just like local investors.

To the extent that there has been rampant speculation in property markets, the causes are Seoul's fiscal profligacy and the credit promiscuity of the Bank of Korea. As elsewhere, persistent problems in economic performance result from policy interventions initiated by politicians seeking electoral support and irresponsible central bankers.


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