By Luke Player
On the MoneyWeek podcast a few weeks ago there was a discussion about the possibility of bringing in regulation to steer investors towards productive investment rather than unproductive investments like speculation in assets such as gold or Bitcoin or trading on hype like the recent GameStop saga. This idea has been around for a while, and in fact has slowly started to be implemented with restrictions on buying certain assets, yet there has been little press coverage of it. This then begs the question, should the decision of what counts as productive or unproductive investing lie with the investor, or should it be regulated by the government?
There is a discussion paper written by the Bank of England ‘Understanding and measuring finance for productive investment’. According to the BoE “Investment is defined as spending that has the potential to expand the capacity of the economy, by adding to capital, knowledge and technology. Investment is productive as long as the expected social return is greater than the expected social cost of capital”. This implies that for investment to be productive there should be a greater increase in social return than the cost of the capital. While this is not directly related to investment in financial markets and more about a firm’s individual investments, I believe the sentiment can be transferred well to financial markets as a basis to decide what investing is productive and what is speculation.
There have already been instances of the Financial Conduct Authority stepping in to stop retail investors from investing in certain securities. At the start of last year, the FCA banned the promotion of speculative illiquid securities which were unlisted bonds that were issued with the purpose of then using those funds for further speculative purchases outside of their business. The FCA detailed that they were worried about retail investors not understanding the high risk of these assets. However, they implemented this regulation with no consultation, and it shows how the regulatory authorities are slowly preventing us from investing however we feel best. Should the FCA get to decide what is too risky for retail investors, or is that a breach of our freedoms?
MoneyWeek went on to speculate that in the coming decades they believed it likely that there would be changes in the way in which capital gains are taxed in order to promote investment in productive assets. There are already differences in capital gains tax depending on the asset you sell. Currently, these differences are only limited to property versus other assets, with property being charged at a rate 8% greater. It is likely that there will be increasing restrictions or changes in tax rates on what investors, specifically retail investors can invest in. The EU recently announced it is considering limiting the numbers of carbon permits that large investors can hold. This is due to the increasing speculation in carbon markets, where large investors, such as hedge funds, are allowed to participate to increase liquidity. This leads to much more volatile carbon prices which makes the transition to cleaner power much less smooth as hedge funds try to use the market as simply another way to make a profit, with no thought for how it impacts the goal of the carbon permits themselves.
Why do governments need to steer investors away from speculative products? If the income surplus of retail investors is spent on further speculative activities that do not add to economic capacity, there will not be enough money put into productive investment leading to future economic stagnation. Financial markets are increasingly tending towards speculative investments, “casino capitalism” is growing, and it is expanding the gap between market prices and the real value of their underlying assets.
The recent GameStop situation where a group of Redditors showed how easy it is to pump up a stock, with GameStop increasing from ~$18 to over $400 in a week has called attention to this “casino capitalism” once again. Apps such as Robinhood have increasingly democratised investing, making it far more accessible to the mainstream. This has led to an increase in regulatory pressure on “casino capitalism” as many investors look to new financial products, options, and penny stocks to make fast money. However, how many of these stocks are sound investments? GameStop is a prime example, with the company struggling immensely during the Covid pandemic its stock should not be one whose price increased so spectacularly. The whole fiasco however has brought greater media coverage onto the increasing levels of speculation in the market, which will likely bring along with it increasing regulation.
Is it such a bad thing for regulators to control what we invest in? Markets are created to allow for surplus income to be channelled to more productive uses and increase economic capacity. However, speculation is rarely based on fundamentals and as such diverts funds away from the investments that are most likely to aid in economic expansion. Therefore, there is a case for regulators to put an incentive using tax breaks for investment in productive companies. The question remains where to draw the line on what is productive or not?
It is almost impossible to answer this question, with such a range of different investment opportunities and an increasing number of alternative ways to invest, the market is simply too complex to sort into productive and unproductive investment. It is likely to be a long time until the market is regulated with different taxes on different asset classes, however, I believe it is also very necessary to make this step to combat the rise of “casino capitalism” and make the market useful again to distribute funds to productive purposes.
With the line between productive investment and speculation being so blurred, how can regulators decide what counts as productive or not? How will investors react to changes like these, especially large institutional investors who have been using the market as their own money-making machine for the past decade?
The views expressed in this article are the author’s own, and may not reflect the opinions of the St Andrews Economist.