Chapter 13, Expectation and Speculation
The State of Confidence
Keynes's Chapter 12, The State of Long-Term Expectation, is crowded with confusions.
It is one of those chapters in which Keynes revels in pure satire and ends by believing his own paradoxes.
All this is in the tradition of Bernard Mandeville, Bernard Shaw and Lytton Strachey, rather than of serious economics.
But as passages from this chapter are often quoted with delighted approval by those who wish to rationalize their antipathy to the system of free enterprise and free markets, it is worth examining them in some detail.
First we must notice that here the definition of the marginal efficiency of capital undergoes what B. M. Anderson called one of its many metamorphoses, and that causes and effects are arbitrarily selected.
The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention.
But economists have not analyzed it carefully and have been content as a rule to discuss it in general terms.
In particular, it has not been made clear that its relevance to economic problems comes in through its important influence on the schedule of the marginal efficiency of capital.
There are not two separate factors affecting the rate of investment, namely the schedule
of the marginal efficiency of capital and the state of confidence.
The state of confidence is relevant because it is one of the major factors determining
the former, which is the same thing as the investment demand schedule, pages 148-149.
We saw that in his original definition of the marginal efficiency of capital, pages
135 through 136, Keynes tied it up with the yield of specific capital instruments or assets,
and particularly with the expected yield of newly produced assets.
But here it is broadened out to mean business profits generally, or rather, expectations
It is hard to see why the relevance to economic problems of the state of confidence should come in only through its important influence on the schedule of the marginal efficiency of capital, particularly if the latter phrase refers merely to the specific yield of new capital assets.
For the state of confidence refers to all future expectations, including the future prices of consumption, as well as capital goods, the future of wage rates, of foreign trade, of the likelihood of war or peace, of a change of political administration, of a Supreme Court decision, etc.
Why should the marginal efficiency of capital be singled out as the sole factor which makes the state of confidence relevant to economic problems?
It is true, of course, that if the schedule of the marginal efficiency of capital is identified with the investment demand schedule, it becomes very important.
Fictions about the Stock Market
Chapter 12 is chiefly an essay and satire, and in order to patronize the behavior of entrepreneurs, and to ridicule the behavior of speculators, Keynes finds it necessary to patronize and ridicule the human race in general.
If we speak frankly, we have to admit that our basis of knowledge for estimating the yield, ten years hence, of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the city of London, amounts to little and sometimes to nothing.
pages 149 through 150.
It is true, of course, and this seems to be mainly what Keynes is saying,
that with regard to the future we can never act on the basis of certainty.
We are not certain that an earthquake will not destroy our house next week.
We are not even certain that the sun will rise tomorrow.
We are forced to act on the basis of probabilities.
But to admit that our knowledge of the future of an investment necessarily contains elements of uncertainty is far different from saying that it amounts to little or nothing.
Keynes's trick in this chapter is to mix plausible statements with implausible statements, hoping that the latter will seem to follow from the former.
It is probable, he declares, that the actual average results of investments, even during
periods of progress and prosperity, have disappointed the hopes which prompted them.
Page 150.
It is probable.
If human nature felt no temptation to take a chance, no satisfaction, profit apart, in
In constructing a factory, a railway, a mine or a farm, there might not be much investment
merely as a result of cold calculation.
Page 150.
This is possible, but it is hard to say whether it is probable.
It is not easy to imagine precisely what would happen if human nature and human motives were
entirely different from what they are.
But then Keynes begins to expatiate upon all the dire consequences which follow from the
separation between ownership and management which prevails today, page 150, and all the
evils which follow from the opportunities which organized stock markets give to the
individual to revise his commitments.
He does this by creating a number of fictions.
One is that people know nothing about the future and chronically guess wildly.
Another is that those who buy and sell shares on the market are ignorant of the companies
in whose shares they deal, and that only the professional entrepreneur has genuine knowledge.
Still another fiction is that professional speculators are not concerned with the real
Expectation comes to mean expectations regarding expectations.
We have reached the third degree where we devote our intelligences to anticipating what average
Average Opinion expects the average opinion to be, page 156.
In this chapter, Keynes is still satirizing the New York stock market of 1928 and 1929.
Today of course it is not hard to see in retrospect that optimism then went to excessive lengths.
Hindsight is always clearer than foresight, and Keynes seems to be preening himself on
on how much better his hindsight of 1936 is than the foresight of the speculative community
of 1929.
But was Keynes sure enough of his ground in early 1929 to sound a clarion warning or to
sell short and make a killing and, incidentally, confer a social benefit by helping to mitigate
excessive optimism?
Probably not, but he explains that there were certain difficulties.
Before we go into his further rhetoric, however, it may be advisable here to make a simple
point.
Whenever men are allowed liberty and freedom of choice, they will make mistakes.
Liberty is not a guarantee of omniscience, but neither are the mistakes of free men a
a valid excuse to take away their liberty and impose government controls in its stead
on the ground that all wisdom and disinterestedness resides in the people who are going to do
the controlling.
I have pointed out before that Keynes disdains to offer serious statistical evidence for
statements that could easily be supported or disproved by available statistics.
For example, day-to-day fluctuations in the profits of existing investments, which are
obviously of an ephemeral and non-significant character, tend to have an altogether excessive
and even an absurd influence on the market.
It is said, for example, that the shares of American companies which manufacture ice tend
to sell at a higher price in summer when their profits are seasonably high than in winter
when no one wants ice.
The recurrence of a bank holiday may raise the market valuation of the British railway
system by several million pounds, pages 153 through 154.
Let us take these statements as they occur.
Contrary to Keynes's first assertion, what nearly always surprises daily market commentators
and outside observers is how little attention the market usually pays to non-significant
and day-to-day fluctuations in profits.
A strike in the steel industry may be front-page news in every newspaper in the country, but
shares of steel companies may not go down at all or only by a tiny fraction.
On the day that the strike is settled, however, and the whole country is breathing an audible
sigh of relief, the steel stocks may go down.
This is always ridiculed in letters to the editor as illogical, but it may happen because,
though operations are being resumed, the higher wage cost involved in the settlement may be
regarded as threatening a reduction of profits in the long term.
Notice how Keynes's second assertion above begins.
It is said, Is such hearsay Keynes's notion of evidence?
Apparently it is, for he offers nothing else. In these days of electric refrigerators, his
illustration of ice manufacturing companies may seem obsolescent. But I have succeeded
in digging up two American ice companies, and I print in Appendix B the high, low and
average prices for each of them in the midwinter period January to February for each of the
In the final column of the July-August average is presented as a percentage of the January-February average.
What do these comparisons show?
They show that the shares of the American Ice Company averaged higher in summer than
in winter in fourteen of these twenty-five years, but actually averaged lower in summer
than in winter for nine of them.
The shares of City Products Company, formerly City Ice and Fuel Company, averaged higher
They were higher in summer than in winter in 12 of those years, but lower in summer than in winter for 9 of them.
Out of 50 cases, in short, the shares of these companies sold higher in summer than in winter only 26 times,
about as often as a penny might come heads instead of tails in 50 throws.
What's here, it may be said, are inconclusive because summer ice companies were usually
also in the winter fuel business.
This is true, but it merely emphasizes the frivolous and apocryphal nature of Keynes's
undocumented illustration.
Keynes's third assertion about bank holidays lends itself more easily to statistical verification
or disproof.
In Appendix C, I present a table comparing the closing bid and asked prices of the Southern
Railway Company's deferred ordinary shares on two specific days out of every year for
the 25 years from 1923 to 1947 inclusive.
The Southern Railway Company has been chosen because it was one of the four main line railway
companies, and did not have dividends falling due in August.
The 25 years from 1923 to 1947 were chosen because amalgamation of the British railways
took effect as from the 1st of January, 1922, when the four main line railway companies
came into being, and because nationalization of the principal railway undertakings was
was effected on the 1st of January, 1948, when they were vested in the British Transport Commission and shareholders received compensation by way of a fixed interest stock, guaranteed as to principal and interest by the British Treasury, and its market prices were not, therefore, influenced by earnings.
Now the most famous English bank holiday, which bears that specific name, is the one that falls on the first Monday in August.
This is the one most likely to show the effect of bank holidays on the quotations of British railways.
Therefore, the table in Appendix C compares the closing bid and asked prices of Southern Railway shares
on the last business day in February, chosen as being furthest away from the August bank holiday and also reasonably away from the Christmas New Year holidays, with the closing bid and asked prices on the first business day after the August bank holiday.
And what do the results show? Comparing the price of each of the two days, we find that in only 7 of the 25 years was the price of these railway shares higher on the day after the August bank holiday than on the last day of February, whereas in 18 of the 25 years it was actually lower right after the August bank holiday.
From Keynes's point of view, this is simply bad luck.
On the mere law of averages, assuming that the bank holiday did not affect the value of railway shares one way or the other,
southern railway shares should have been higher at bank holiday time about as often as they were lower.
I attach no significance to the fact that the result turns out to be exactly the reverse of that of Keynes's unsupported statement.
Statement, but the actual comparison is a good lesson against making sarcastic jibes
at the expense of the speculative community on the basis of unconfirmed and, as it may
turn out, quite false information.
Keynes next attacks professional speculators.
They are concerned, he writes, not with what an investment is really worth to a man who
who buys it for keeps, but with what the market will value it at, under the influence of mass
psychology, three months or a year hence.
Page 155.
And this behavior is an inevitable result of the mere freedom to buy and sell securities.
For it is not sensible to pay 25 for an investment of which you believe the prospective yield
Such reasoning on the part of a professional speculator is of course possible, but it is preposterous to regard it as usual.
It assumes a speculator saying to himself something like this.
I know from my own sources of information that this stock I can buy now for 25 is really
worth 30 on the basis of what it is going to earn, but I have a hunch that some apparently
bad news is going to break within the next few months, and though I know that this will
not adversely affect the real value of this stock, other people who constitute the majority
will be foolish enough to be influenced by this news, and therefore they will push the
quotation of this stock down to twenty, even though more people by that time will know
as I do that the stock is really worth thirty on the basis of yield, etc., etc.
It is a byword in Wall Street that people who turn this number of mental somersaults
to arrive at a conclusion quickly go broke.
Contrary to what Keynes supposes, it is the speculators who try to figure out what the
real future values of stocks are going to be who are most likely to come out best in
the long run.
Many seasoned speculators got out of the market in 1928 for the sound reason that stocks were
selling too high in relation to existing or likely earnings.
Then, seeing the market still going up, some of them decided to jump in again on the assumption
and that the others were not only crazy but could be safely counted upon to go still crazier.
It was the speculators who threw away their own sensible calculations in a cynical effort
to beat the mob psychology who got caught.
But Keynes is firmly convinced of the opposite.
Investment based on genuine long-term expectation is so difficult today as to be scarcely practicable.
He who attempts it must surely lead much more laborious days and run greater risks than
he who tries to guess better than the crowd how the crowd will behave, page 157.
Keynes apparently believes this precisely because it is so implausible.
It is the long-term investor, he who most promotes the public interest, who will in
and practice come in for most criticism, wherever investment funds are managed by committees
or boards or banks.
If he is successful, that will only confirm the general belief in his rashness, and if
in the short run he is unsuccessful, which is very likely, he will not receive much mercy.
To one who, like the present writer, spent many years writing daily on the stock market
for New York newspapers, the foregoing sounds suspiciously familiar.
It sounds like a man who once gave investment advice that turned out to be wrong and who
was looking for an alibi.
It is the system that made the mistake, not he.
The stock he recommended should, in all logic, have gone up to 108, even though it never
did.
But such suspicions are unworthy, and I shall return to the merits of the argument.
Gambling Speculation Enterprise
What is it that Keynes is trying to prove?
He is trying to prove that liquidity is wicked, that the freedom of people to buy and sell
securities in accordance with their own judgment ought not to be allowed, and that their money
ought to be taken from them and invested by bureaucrats omniscient and beneficent by definition.
Of the maxims of orthodox finance, none, surely, is more antisocial than the fetish of liquidity.
The doctrine that it is a positive virtue on the part of investment institutions to
concentrate their resources upon the holding of liquid securities.
It forgets that there is no such thing as liquidity of investment for the community as a whole.
Page 155.
It is true that there is no such thing as liquidity of investment for the community as
a whole, but only if this means the world community.
The British, for example, can't relieve a crisis by selling their American shares.
Any individual country can sell or buy gold or dollars, etc.
But even if we grant that there is no such thing as liquidity of investment for the world,
considered as one big community, this does not mean that liquidity cannot still be of
considerable advantage to individual countries, individual banks, individual corporations,
or individual persons, and therefore of advantage to the community as a whole.
On the same kind of reasoning as he used in this instance, Keynes could have argued that
fire insurance is worthless because someone must bear the loss of the fire.
It is true that someone must bear the loss, but the whole purpose of insurance is to distribute
and diffuse the loss, and this is what liquidity also serves to do.
It is easy to see how much good can come, and it is difficult to see how much harm can
This is why there is no point to Keynes's complaint that,
to outwit the crowd and to pass the bad, or depreciating, half-crown to the other fellow.
Page 155
This is a peculiarly unfortunate image for Keynes, the advocate of government spending, deficit financing and inflation to have used.
For if the half-crown is depreciating, it is depreciating because the politicians are printing too much money,
and if the half crown can be passed on despite the other fellows unwillingness to take it, it is because the politicians have made it legal tender.
Keynes forgets that what he is describing is not merely the purpose of stock market speculation, but the purpose of enterprise as well.
For the entrepreneurs who make the greatest profits will be the minority who first and best anticipate the wants of consumers,
Summers, who, if Keynes wishes to put it that way, beat the gun as compared with the majority
of their competitors.
Keynes once derided economists who worried about results in the long run.
In the long run, he said cynically, we are all dead.
It is amusing to find the same man complaining here that long-run considerations are minimized
because human nature desires quick results, there is a peculiar zest in making money quickly,
and remotor gains are discounted by the average man at a very high rate.
Page 157.
But for Keynes, any stick was apparently good enough to beat the capitalist system with.
In attacking speculation in Wall Street, Keynes forgets that all enterprise, all human activity,
extricably involve speculation, for the simple reason that the future is never certain, never
completely revealed to us.
Who is a greater speculator than the farmer?
He must speculate on the fertility of the acreage he rents or buys, on the amount and
distribution of rainfall over the coming crop season, on the amount of pests and blight,
on the final size of his crop, on the best day to sow and the best day to harvest and
and his ability to get help on those days.
And finally, he must speculate on what the price of his crop is going to be when he markets
it or at what day or price to sell for future delivery.
And even in deciding how much acreage to plant to wheat or corn or peanuts, he must guess
what other farmers are going to plant and how much they are going to harvest.
It is one speculation after another, and he and every entrepreneur in every line must
act in relation to some guess regarding the actions of other entrepreneurs.
When all this is kept in mind, Keynes's attack on speculation begins to look pretty silly.
His contrast between speculation and enterprise is false.
If he is merely attacking bad speculation, then it is bad by definition.
But intelligent speculation, as economists and market analysts have pointed out over
and over, mitigates fluctuations, broadens markets, and increases production of the types
of goods that consumers are most likely to want.
speculation is an indispensable and inherent part of intelligent production.
But Keynes deplores human freedom.
He seems to deplore practically all the financial progress of the last two centuries.
Speculators may do no harm as bubbles on a steady stream of enterprise, but the position
is serious when enterprise becomes a bubble on a whirlpool of speculation.
When the capital development of a country becomes a by-product of the activities of
a casino, the job is likely to be ill done.
The measure of success attained by Wall Street, regarded as an institution of which the proper
social purpose is to direct new investment into the most profitable channels in terms
of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire
capitalism.
159.
This tirade, which treats speculation as merely a synonym for gambling, reflects the prejudices
of the man in the street.
The difference between gambling and speculation is clear.
In gambling, the risks are arbitrarily invented or created.
In speculation, the risks already exist, and somebody has to bear them.
In gambling, one man wins $1,000 and another loses it, depending on whether a ball falls
into an odd or even number on a roulette wheel or on which horse comes in first on a racetrack.
But the wheel could be spun and the race could be run without the betting, without either
losses or gains.
The world would probably be richer rather than poorer if gambling casinos and racetracks
did not exist at all, but it is not so with the great organized exchanges, either for
commodities or for securities. If these did not exist, the farmer who raises wheat would
have to speculate on the future price of wheat, but as they do exist, the farmer or miller
who does not wish to assume this risk can hedge, so passing the risk on to a professional
and Professional Speculator. Similarly, a corporation manager who knows how to make air conditioners but does not wish personally to assume all the financial risks involved from the vicissitudes of competition and of changing market conditions for air conditioners may offer stock on the market and let investors and professional speculators assume those financial risks.
Thus, each job is done by a specialist in that job, and is therefore likely to be better
done than if either the producer or the speculator tried to do both jobs.
The market consisting of human beings, unable to foresee the future with certainty, will
make mistakes, and some of them, in retrospect, will look like incredible mistakes.
Yet Wall Street, notwithstanding its academic and political detractors, can be claimed as
one of the outstanding triumphs of laissez-faire capitalism.
The results speak for themselves.
The United States has achieved the greatest volume of investment, the greatest capitalistic
development, the greatest volume of production, the greatest economy of manpower, the highest
Standard of Living that the world has ever known, and it has been able to do this in
an important degree precisely because of the help rendered by the marvelous financial organization
centered in Wall Street and not in spite of it.
Surely it should have struck Keynes and his followers as worthy of notice that the country
with the greatest gambling casinos and the greatest liquidity was also the country with
with the World's Greatest Capital Development and the Highest Average Standard of Living.
But Keynes carries his hostility to freedom to the point where he suggests the introduction
of a substantial government transfer tax on all transactions as the most serviceable reform
available.
Page 160 Continuing, he declares,
The spectacle of modern investment markets has sometimes moved me towards the conclusion
that to make the purchase of an investment permanent and indissoluble, like marriage,
except by reason of death or other grave cause, might be a useful remedy for our contemporary
evils.
Page 160.
He draws back from this totalitarian suggestion for a moment, only to work himself up again.
So long as it is open to the individual to employ his wealth in hoarding or lending money,
the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive.
Page 160.
The only radical cure for the crises of confidence would be to allow the individual no choice
between consuming his income and ordering the production of a specific capital asset.
161, for people don't know what they are doing anyway.
Most probably of our decisions to do something positive can only be taken as a result of
animal spirits, of a spontaneous urge to action rather than inaction, and not as the outcome
of a weighted average of quantitative benefits multiplied by quantitative probabilities.
Mises only pretends to itself to be mainly actuated by the statements in its own prospectus
p. 161-162 Free private investment depends upon the nerves
and hysteria and even the digestions of private investors, p. 162, on whim or sentiment or
chance, p. 163.
And what is all this leading up to?
The denouement comes in the final paragraph of the chapter.
For my own part, I am now somewhat skeptical of the success of a merely monetary policy
directed towards influencing the rate of interest.
I expect to see the State, which is in a position to calculate the marginal efficiency of capital
goods on long views and on the basis of the general social advantage, taking an ever greater
responsibility for directly organizing investment.
Page 164 So there you have it. The people who have
earned money are too short-sighted, hysterical, rapacious and idiotic to be trusted to invest
in themselves. The money must be seized from them by the politicians who will invest it
with almost perfect foresight and complete disinterestedness, as illustrated, for example,
by the Economic Planners of Soviet Russia.
For people who are risking their own money will of course risk it foolishly and recklessly,
whereas politicians and bureaucrats who are risking other people's money will do so only
with the greatest care and after long and profound study.
Naturally, the businessmen who have earned money have shown that they have no foresight,
The politicians who haven't earned the money will exhibit almost perfect foresight.
The businessmen who are seeking to make cheaper and better than their competitors the goods
that consumers wish and whose success depends upon the degree to which they satisfy consumers
will of course have no concern for the general social advantage.
But the politicians who keep themselves in power by conciliating pressure groups will
will of course have only concern for the general social advantage.
They will not dissipate the money for hair-brained peanut schemes in East Africa, or for crop
supports that keep sub-marginal farmers in business and sub-marginal acreage in cultivation,
or to build showy dams and hydroelectric plants that cannot pay their way but can swing votes
in the districts where they are built, or to set up reconstruction finance corporations
or small business administrations to make loans to projects in which nobody will risk
his own money.
There will never be even a hint of bribery or corruption or the gift of a mink coat to
a minor official by the beneficiary of the loan.
This is the glorious vista that Keynes unveils.
This is The New Economics.