“All Stock Exchanges provide for the arbitration of disputes which may occur between members, and if both parties are willing, between members and their customers. They also prescribe rules governing the nature of contracts, the making of all offers and bids, the registry and transfer of securities on the transfer books of the corporations, and the conditions upon which securities may be listed upon the Exchange for trading purposes. Practically all stock Exchanges also require that all transactions must be real, and that no fictitious or unreal transactions shall be permitted; that discretionary orders cannot be accepted by brokers; and that every member of the Exchange must keep complete accounts, subject at all times to examination by the governing committee or any standing or special committee of the Exchange, and under penalty of suspension, no member may refuse or neglect to submit such accounts, or wilfully destroy the same. Nor may any member, under pain of suspension (a serious penalty, involving not merely the loss of the rights and privileges of membership, but also the stigma attaching to the member as a factor in the business community), be guilty of ‘any conduct or proceeding inconsistent with just and equitable principles of trade.’”[12]
One of the most important functions of the Stock Exchange is, as we have seen, the almost automatic ease with which it directs reservoirs of capital into channels of usefulness in the world’s industry and commerce. The layman may feel that this use of the Stock Exchange does not affect him as an individual, but it does, and vitally. Every merchant and every manufacturer, great and small, all over the world, is directly benefited by it. One may see, for example, securities of railway equipment companies quoted for weeks at a low level. This shows that the business of these companies is not profitable, and it serves to discourage owners of capital from undertaking new enterprises in that direction, because the securities of such companies cannot be sold. Moreover, it shows investors, as plainly as words can tell, that this is an unsafe and unprofitable form of investment.
Reverse the situation, and lines of industry are revealed where high and advancing prices of securities indicate a rising tide of business, with an outlook for large profits in the future. Capital then takes hold cheerfully; there is a market for the new securities and a proper basis for fresh commercial development, because investors and speculators have learned from the published daily quotations of these Stock Exchange securities that there is good warrant for the flow of capital into such channels, and that a reasonably safe return will follow an investment in them. In commenting upon these functions of the Stock Exchange, Mr. Conant says: “Through the publicity of knowledge and prices, the bringing of a multitude of fallible judgments upon this common ground, to an average, there is afforded to capital throughout the world an almost unfailing index of the course in which new production should be directed.” Through the mechanism of the Stock Exchange, therefore, the public determines the direction in which new capital shall be applied to new undertakings. In this way our great railways were built, our Western country opened to progress, and our vast industrial undertakings made possible.
“The stock market acts as a reservoir and distributor of capital, with something of the same efficiency with which a series of well-regulated locks and dams operates to equalize the irregular current of a river. The hand of man is being stretched out in the valley of the Nile to build great storage basins and locks, and the waters which flow down the great river may be husbanded until they are needed, when they are released in small but sufficient quantities to fertilize the country and tide over the periods of drought. Something of the same service is performed for accumulation of capital by the delicate series of reservoirs, sluice gates, and locks provided by the mechanism of the stock market. The rate of interest measures the rise and fall of the supply of capital, as the locks determine the ebb and flow of the life-giving water. The existence of negotiable securities is in the nature of a great reservoir, obviating the disastrous effects of demands which might drain away the supply of actual coin, and preventing the panic and disaster, which, without such a safeguard, would frequently occur in the market for capital.”[13]
Some day, no doubt, the United States will become a great creditor nation, as England is, and then the field of these operations will be extended to other countries. When that time comes we shall take a hand, through the machinery of the Stock Exchange, in the development of new and immense fields of human endeavor just as London does to-day. To what extent could capital exports of such tremendous economic significance continue if so useful and so indispensable an institution as the Stock Exchange were abolished or interrupted? It was Burke who said that “great empires and little minds go ill together,” and so it is with great markets and little critics. There can be no worthier purpose in the commercial world than the upbuilding of a great centre of credit designed to finance material enterprise, enrich the world, and extend the benefits of civilization to new lands and new people, based upon the credit supplied by the banker, the money provided by the speculator and investor, and the safeguards afforded by the Stock Exchange. And yet, curiously, the greater the effort in these directions, the greater the criticism. Just in proportion to the perfection with which all these agencies equalize prices, economize time and effort, and protect the public, so they seem to attract attention, comment, and attack.[14]
In Wall Street, according to this viewpoint, everything is tainted, sinister, reprehensible, covetous and unscrupulous, just as it follows the onward march of invention, science, and progress. This sort of criticism will not, of course, continue. The man in the street--the average layman to whom I have ventured to address this chapter will learn sooner or later--in point of fact he is learning now--that the questionable practices in Wall Street which started all this hubbub, and which were a natural and a human accompaniment of the slowly developed technique of this or any other business, have now been effectually stopped. It has been a very long time, for example, since Jay Gould ran his printing-press for Erie certificates, and that incident cannot possibly happen again. The Keene type of manipulator has gone, never to return. “Corners,” too, have seen their last day on ’Change, and so also have other artificial impediments in the way of natural supply and demand. It has been years since the Cordage scandal, and the Hocking Coal incident marked the end of that form of manipulation. Yet there are persons who talk of these things as though they were daily occurrences, overlooking the fact that the New York Stock Exchange, by its own efforts put a stop to the evils complained of, and will never tolerate their return.
McMaster in his “History of the People of the United States” tells us that in the early days in New England public sentiment was so aroused against the legal profession that lawyers “were denounced as banditti, as blood-suckers, pick-pockets, windbags and smooth-tongued rogues.” At that period in our history feeling ran so high against banks and bankers that Aaron Burr was only able to procure a charter for the Manhattan (Banking) Company by resorting to the subterfuge of naming it, in the Act, “a Company to furnish the City with water.” No doubt all this rancor and hostility seemed a very serious matter to the lawyers and bankers of those days, just as the criticism of to-day strikes home to members and friends of the Stock Exchange.
The lawyers made many mistakes a century and a half ago when the code and its practice were imperfectly understood in this country; so it was with the early history of banking; and so in our time Wall Street and the Stock Exchange have made the mistakes which any gradually developing form of enterprise must make. But these mistakes are dead or dying, and, in their place, no doubt, there will come a better understanding all around. When that day dawns the thoughtful American will realize that the particular rôle which the Stock Exchange plays in promoting all forms of commercial endeavor is a boon such as no country in the history of earlier days ever enjoyed. He will contemplate his country’s progress with pride; he will rejoice in its capacity to outstrip other countries; he will acclaim its advancement toward the proud position now held by England, the banker and the clearing-house of the world. And he will learn--this thoughtful citizen--that material achievements like these cannot be attained without a market for capital and a market for securities.[15]
CHAPTER II
THE USES AND ABUSES OF SPECULATION
Somewhere in each one of us lurks Stevenson’s spirit of “divine unrest,” the parent of speculation. To-day, as in wise old Greece in the morning of the world, philosophers sit under every tree, speculating upon the phenomena of the universe, and upon the practical application of them to the needs of humanity. Thus Archimedes came to know of things that we now call Copernican, seventeen centuries before Copernicus was born; thus Columbus and his argosy sailed into the great unknown, speculating upon an irrational and even shocking exploit; thus Pasteur saved to France through the meditations of his speculative mind a sum greater than the cost of the Prussian war and the colossal indemnity that followed it.
And so the “divine unrest” goes on and on, impelling men to speculations and explorations of the physical world and of the world that lies beyond our primitive senses, with here and there a high achievement, and now and then a miserable failure, but always on and on. The hypothesis of the spectacled professor blossoms into a boon; the dream of the inventor becomes a benefaction; the forlorn hope of the explorer points the way to wealth. Things that were speculations yesterday become realities to-day. To-morrow?--nobody knows. In a free field, not bounded by formulæ nor restricted by law of God or man, with money to encourage it and enterprise to spur it on, what may come from the speculations of the future passes understanding.
Now speculation is an all-embracing word, overworked, threadbare, and worn to the bone. Originally it meant “to see”; then “to view,” “watch,” “spy out”; then “exploration” or “contemplation.” When thrift came into the language and men ceased burying their gold, it began to take on a new meaning. The spirit of legitimate adventure, that entered men’s minds when the Most Christian Kings abandoned brute force and repudiation, led men to buy things in the hope of selling them at a profit. It was risky business at first, and capital, then as now, was timid. The High Finance of the Middle Ages was not easily forgotten. But little by little channels through which enterprise might flow into wealth came into being, and confidence came with them. This was called speculation.
By the time Adam Smith wrote his “Wealth of Nations” (1776) the word was firmly fixed in the language. “The establishment of any new manufacture,” he said, “or any new branch of commerce, or of any new practice in agriculture, is always a speculation from which the projector promises himself extraordinary profits.” How the early channels of speculation broadened into great rivers, how confidence grew as the art of making money and increasing it developed, how credit became established, how speculation led to the opening of new countries and the extension of immense advantages, through civilization, to the people of those countries--all this is a fascinating story. And yet the speculation of to-day is no different in its elementals from that of the early Greeks; the same spirit of “divine unrest” that spurs on the philosopher in his study stimulates the explorer of strange lands, beckons on the engineer and the builder of railways, and attracts the capital of the adventurous investor. We cannot stop it if we would, because hope, ambition, and avarice are fundamentals of human nature. The police cannot arrest them; they are fixed and immutable.
If there is more speculation in material things to-day than there ever was before, it is because there are more things to speculate in, more money to speculate with, more people to speculate, and more machinery, like telephones and telegraphs, to facilitate speculation. Capital, credit, and new undertakings grow day by day and open new avenues of possible profit. The per capita wealth of nations, growing by what it feeds on, constantly seeks new fields for enterprise and adventure. The intelligence of the people increases by leaps and bounds, and goes peering curiously into all the little nooks and crannies of the world for opportunities of gain--the apotheosis of speculative enterprise.
All forms of human endeavor in material things are, or were at their beginning, speculations. Every ship that goes to sea carries with it a speculation, and leaves another one behind it at Lloyds. Every man who insures his life or his house buys a speculation, and every company that insures him sells one. The farmer speculates when he fertilizes his land, again when he plants his seed, and again when he sells his crop for future delivery, as he often does, before it is planted or before it has matured. The merchant contracts to fill his shelves long before spring arrives; he is speculating. The manufacturer sells to him, speculating on the hope or belief that he will be able to buy the necessary raw material, and again on the labor, the looms and the spindles necessary to make the delivery. In the South the grower of cotton and in Australia the grower of wool are likewise speculating on the probability of a crop and on the price at which they may sell to this manufacturer. It sounds like “this is the house that Jack built” in its endless chain of sequences; a chain, indeed, and one no stronger than its weakest link. Interfere with any part of it, and the whole commercial structure which it binds together falls apart. The grower, the manufacturer, and the merchant _must_ speculate.
There was twofold speculation on the part of our great financial barons who built our transcontinental railways, for they had to reckon not only upon the probability of profit in their undertakings but likewise upon the willingness of other speculators--you and I--to assist them by buying a part of the securities which represented the outlay. To be sure it so happened that many of these vast speculations at first proved unsound. Some of them were a little premature; others pushed too far; they brought disaster upon the speculators who had put money into them. And yet who shall say that our great railways have failed to enrich the world and spread the comforts of civilization? “But for a verdant and evergreen faith,” says a recent writer, “salted with the love of risk and adventure for their own sakes, how could mountains be bored and waters bridged? If there were not superstition there could be no religion; if there were not bad speculation there could be no good investment; if there were no wild ventures there would be no brilliantly successful enterprises.”
This is not hyperbole; it is fact. The world of business and enterprise must go on; it cannot stop. As it goes on capital must be enlisted, which is another way of saying that speculators must be attracted. The only way that has been devised to attract them is through the medium of certificates of ownership or evidences of debt, called securities. But the business does not end there, for, as we have seen in the previous chapter, the capital of speculators will not take hold unless a market is provided. They want to know where they stand; before they venture upon the troubled waters of new enterprises they must be assured of a public market, a harbor where they can get ashore quickly if storms are brewing.
The only plan that the ingenuity of man has thus far devised to meet this emergency is a Stock Exchange. One man, or two, or a hundred cannot make a market, because the immense volume and variety of these securities make it impossible for any unorganized handful of brokers and dealers to determine a fair market price. What is required, and what the man whose capital is wanted insists upon, is an organized body of brokers, speculators, and investors competing keenly, seeking to buy cheap and sell dear, gathering and disseminating all the news, and so sharpening the judgment and stimulating the higgling of buyers and sellers as to bring prices to their legitimate level and give them stability. Ten thousand competitors in this business of bringing prices and values together are of course better than one thousand; a hundred thousand would be better still. The Stock Exchange supplies this want, and will continue to supply it until a better plan is devised.[16] Meantime, since it has grown to its present stature by forms of speculation necessary to the maintenance of enterprise, any serious interruption of the facilities it affords will bring enterprise to a standstill and cause the whole sensitive structure of credit to collapse in terror. Let Professor Seligman explain this matter:
“If a railway or other industry, in launching a new enterprise, had to depend on the chance investors at the time of the issue of the securities, it would be seriously hampered. The mere knowledge that at any moment there will be a ready sale on the Exchange greatly increases the circle of purchasers, many of whom may not intend to be permanent investors. The Stock Exchange aids the investment of capital, as the Produce Exchange aids the production of finished commodities. Business orders and corporate needs are intermittent, because they depend on temporary exigencies; the risks at one end, at all events, are eliminated by the unintermittent, continuous market which regular speculation affords. The Cotton Exchange was the result of the disorganization of the cotton trade after the Civil War; speculation in all other staples has in the same way been the consequence of the efforts of the manufacturer to avert the risks of intermittent and spasmodic fluctuations in the raw material. The result of regular speculation is to steady prices. Speculation tends to equalize demand and supply, and by concentrating in the present the influences of the future it intensifies the normal factors and minimizes the market fluctuation. Speculation so far as it has become the regular occupation of a class, differentiated from other business men for this particular purpose, subserves a useful and in modern times an indispensable function.”[17]
Here we have an authority who tells us that speculation in securities, no less than in raw materials, is “an indispensable function” if business is to go ahead. The last census shows that 32½ per cent. of the population of the United States is composed of laboring men, not counting agricultural workers. This large army of men is by no means independent; on the contrary it is strictly dependent on the ability of others to give it employment. Shut down the factories, curtail the operations of railways, close the mines and quarries, stop building and new construction, and in greater or less degree suffering and privation among these large masses must ensue.
Now go a step further, and we find that the managers of these railways, mines, and factories, are in turn dependent--wholly dependent upon capital. They cannot go ahead with the extensions and improvements necessary to efficiency without borrowing money; and credit, in turn, will not come to their support unless a broad market is provided, through the Stock Exchange, for the securities which represent these obligations. Hence we see that just as every farmer in the West and every cotton-grower in the South must have a stable market for his products, so every laborer in our great industrial field is directly concerned with the maintenance of a stable market for the securities of the company that employs him. The interests of one are the interests of all, and speculation, in one form or another, underlies all industrial progress. “Complaint is made of the evils of speculation,” said the greatest of French economists, “_but the evils that speculation prevents are much greater than those it causes_.”[18]
Now that we have reached a point in our discussion that brings us face to face with the so-called “evils” of speculation on the Stock Exchange, let us pause and consider the difference between speculation, which is held by many to be abhorrent, and investment, which is generally thought right and proper. The first thing we encounter is the shadowy and indistinct boundary line that separates the one from the other. Does any one know where the one begins and the other ends? France has more conservative investors than any other country, yet, as Mr. Hirst puts it, the most critical and hidebound buyer of French rentes is a speculator in the sense that he not only wishes his purchase to yield him interest, but also hopes and expects that sooner or later he will be able to sell out at a profit, all of which is legitimate, proper, and human. The first question every man asks when the time comes to invest is, “Is this a good time for investment?” “Am I buying cheap?” by which he means “Are these investments likely to enhance in value?”
He may have bought Spanish bonds at low prices during the war between Spain and the United States--a somewhat speculative investment--and in his purchase he believed himself an investor in a strict sense. Yet, when those bonds recovered to a normal basis and he sold out at a profit, was it speculation, or investment, or a little of both, that defined the trade? British consols are low to-day, and there is of course no safer investment, but the investor who buys them is influenced by the fact that a long period of peace seems to lie ahead, with reduced expenditures for armament and hence with diminished borrowings by the Government leading to a substantial recovery in the price of these solid securities. Such a man is “speculating” on England’s abstention from war, on its limitation of military and naval expenditures, and on the probable effects of these matters on the price of his consols.[19]
The truth seems to be that all investment is speculation, differing from it in degree but not in kind. This salient fact was recognized as long ago as 1825, when, despite the comparatively limited field for investment enterprise, McCulloch saw what was coming and grasped the true idea of the part speculation and its handmaiden, investment, were to play in the industrial renaissance. Coming at a time when speculation was new, and subjected, as all innovations are, to widespread criticism and doubt, his words have prophetic significance.
“It is obvious that those who indiscriminately condemn all sorts of speculative engagements have never reflected on the circumstances incident to the prosecution of every undertaking. In truth and reality they are all speculations. Their undertakers must look forward to periods more or less distant, and their success depends entirely on the sagacity with which they have estimated the probability of certain events occurring, and the influence which they have ascribed to them. _Speculation is, therefore, really only another name for foresight_; and, though fortunes have sometimes been made by a lucky hit, the character of a successful speculator is, in the vast majority of instances, due to him also who has skilfully devised the means of effecting the end he had in view, and who has outstripped his competitors in the judgment with which he has looked into futurity, and appreciated the operation of causes producing distant effects.”[20]
A quarter of a century later we find England’s foremost thinker sounding the same clear note. John Stuart Mill was by no means a hermit philosopher feeding on theories. Traveler, sportsman, business man, statesman, and author, he saw things broadly and wrote for practical men. “Speculators,” he said--and he was speaking of the “greedy” ones who buy and sell for gain--“have a highly useful office in the economy of society. Among persons who have not much considered the subject there is a notion that the gains of speculators are often made by causing an artificial scarcity; that they create a high price by their own purchases and then profit by it. This may easily be shown to be fallacious.” He then shows, what I have outlined elsewhere, that the market is larger than any speculator or group of speculators, and, if this was true in 1848, I think it will not be disputed that it is quite true to-day.
Continuing, Mill says: “The operations of speculative dealers are useful to the public whenever profitable to themselves. The interest of the speculators as a body coincide with the interests of the public; and as they can only fail to serve the public interest in proportion as they miss their own, _the best way to promote the one is to leave them to pursue the other in perfect freedom. Neither law nor opinion should prevent an operation, beneficial to the public, from being attended with as much private advantage as is compatible with full and free competition_.” Mill makes no distinction here between investors and speculators; they are one and the same. In any case it is conceded that speculation is what makes the markets to-day, since 90 per cent. of the transactions that take place daily on the world’s Stock Exchanges are speculations pure and simple. And this is a good thing. Before we go on with our subject, let Professor Emery explain why, and bring the teachings of McCulloch and Mill down to our own day:
“Speculation has become an increasingly important factor in the economic world without receiving a corresponding place in economic science. In the field in which it acts, in the trade in grain and cotton and securities and the like, speculation is the predominant influence in determining price, and, as such, is one of the chief directive forces in trade and industry. But treatises in the English language on general economic theory and conditions have given very little space to this influence, which is fundamental in the world of economic fact....
“It is true that forty years ago speculation was far less important than it is now, and there was, therefore, more justification for disregarding it. Professor Hadley has given due consideration to the new conditions which prevail in modern business. At the same time it should be remembered that McCulloch, already in his day, had grasped the true idea of the function of speculation, a fact shown by the incorporation of his treatment of the subject into his chapters on Value. Wide as is the influence of speculation, its force is felt primarily in the field of prices. By making prices it directs industry and trade, for men produce and exchange according to comparative prices. Speculation then is vitally connected with the theory of value.
“From the point of view of theory, therefore, it is incorrect to attach so little importance to the function of speculation; in practice it is impossible to deal intelligently with the evils of the speculative system without first recognizing its real relation to business. Both the writer and the reformer must reckon more than they have yet done with the fact that speculation in the last half century has developed as a natural economic institution in response to the new conditions of industry and commerce. It is the result of steam transportation and the telegraph on the one hand, and of vast industrial undertakings on the other. The attitude of those who would try to crush it out by legislation, without disturbing any other economic conditions, is entirely unreasonable.”[21]
Now we come to the evils of the business. That there are evils, really serious ones, no one will deny. To be sure many of the phases of speculation that are called evils are not evils at all; the statements made concerning them have what Oscar Wilde termed “all the vitality of error, and all the tediousness of an old friend,” and yet, although the prevalent criticism is often stupid and superficial, there are undeniably offensive forms of speculation that one would like to see suppressed. Speculation is a comparatively new phenomenon, and it has brought with it dangers and pitfalls. So also have automobiles, electricity, and steam engines. But while the Stock Exchange has created the arena for the display of these abuses, it has not originated them “except,” as a recent writer puts it, “in the sense in which one may say that private property has originated robbery.”
The great evil of speculation consists in the buying of securities or real estate or anything else with borrowed money, by uninformed people who cannot afford to lose. Its commonest form in speculation in securities is what is known as “margin” trading, this name being derived from the fact that the buyer, instead of paying cash in full for his purchase, deposits only a fractional amount of its cost, which is intended to serve as a margin to protect the broker from loss, while the broker pays the remaining sum necessary to complete the actual purchase. Thus the speculator may deposit $1000 on securities costing $10,000, while the broker furnishes the additional $9000. It is a system in use everywhere; on the London Stock Exchange it is called “Cover,” on the Paris Bourse, “La Couverture.”
There is no fixed amount of margin called for by brokers, as circumstances differ widely with the character of the securities dealt in, the standing of the buyer, and the condition of the market; but in a broad way it may be said that members of the New York Stock Exchange exact a margin equivalent to ten points on middle-grade speculative issues, twenty points on high-priced and erratic securities, and five points on very low-priced shares that move slowly. There are, of course, certain securities on which no payment short of actual outright purchase in full would be accepted by reputable brokers, while on the other hand, in the case of securities that fluctuate but slightly, such as our government, state, or municipal bonds, a 5 per cent. margin would be ample. This is also the practice in London and Paris, generally speaking. In Paris the _Agents de Change_ always insist upon a greater margin than the _Coulissiers_, or outside brokers, and here members of the New York Stock Exchange invariably pursue the same policy.