Editor’s note: David Pisarra, author of “What’s the Point?” is on vacation.

Everywhere today government bureaucrats and media pundits blame unwanted price movements on speculators and short-sellers. If prices are “too high” — it’s the fault of greedy speculators; if prices are “too low” — it’s the work of evil short-sellers. To hear these critics tell it, speculators have the ability to create artificially high prices, while short-sellers can only destroy sound companies. Ignore for now the obvious question: “Where are the short-sellers in markets that are ‘too high’ and the speculators in markets that are ‘too low’?”

The critics then claim that since neither speculators nor short-sellers perform any positive economic function, barring them from the marketplace is an appropriate remedy, one that’s long past due (recently the United States did just this by making some shorting illegal).

So to begin, let’s ask what the critics consider a “correct” price? Clearly it’s not the price which one obtains when all market participants are free to engage in trade based on their best judgment, because this is precisely the free-market price — a price which they so vociferously condemn. But if “too low” and “too high” aren’t judged relative to the free market, what is the standard? Stripped of euphemism: their wishes.

For example, they wish — contrary to all relevant facts — that oil be priced at $20/barrel and that Lehman’s stock trade at $80/share. Never mind that environmental policy has prevented the drilling of oil and the development of nuclear power for decades now, or that Chinese and Indian oil consumption is growing relentlessly; forget too that Lehman chose to leverage itself at 35:1 and made riskier trades year after year — if these critics wish for a price, then that should be the price, facts be damned!

But of course, attempting to set prices by wishing doesn’t — and can’t — work, not for Lenin, Stalin or Brezhnev; or for Paulson, Bernanke and Bush. If prices are to reflect reality, they must be the result of an objective process of discovery and judgment performed by interested actors.

So just as doctors specialize in identifying and evaluating the facts affecting health and disease, speculators and short-sellers specialize in identifying and evaluating the facts pertinent to market prices. They make it their business to understand economic facts like supply and demand, and then risk their capital on their judgment, properly profiting if they’re right and losing if they’re wrong. Thus in a free market, rather than prices being set by wish or decree, they are set by a rational process, one which benefits from the knowledge of all who participate.

For instance, if speculators believe that future oil supplies won’t match demand, they buy oil, increasing its price. If they’re right, and oil prices continue to increase, they sell their positions, profiting from their insight but also capping prices as their supply comes to market; furthermore, their initial effect on prices signals to the market that greater oil supplies are needed and reduced oil consumption is appropriate — efficiently allowing market participants to adjust their actions to the facts.

So too for short-sellers. If they judge that Enron is cooking the books, or that Lehman is insolvent, they can seek to profit from their insight by short-sales. These lower stock prices in the present and convey to the market that there are potential problems with the companies, helping others avoid losses in the stocks. And if shorts are proved correct, rather than exacerbating any price slide, they actually mitigate price declines when they buy their positions back. Of course, short-sellers, like speculators, only profit if their judgment is correct. If they short a productive, undervalued firm, say, e.g., Wal-Mart or Apple, they lose when the actual facts belie their predictions.

Consider the recent failure of Lehman, where critics claim that short-sellers caused the decline by obscuring and distorting the company’s true value. The facts say otherwise. When the government shopped Lehman to potential buyers, opening the books to them, not a single buyer emerged, not at any price! Everyone who examined the company concluded it was worthless. This was the fact that short-sellers grasped earlier than others — it wasn’t a fact they created.

Speculators and short-sellers don’t create facts, they seek to identify and respond to them; and in the process they help adjust prices to economic conditions and establish smooth and liquid markets. As a result, instead of being scapegoated and banished, they should be respected and welcomed for the productive role they play in our markets.

Amit Ghate is a guest writer for the Ayn Rand Center for Individual Rights, a division of the Ayn Rand Institute. He is a full-time trader who often speculates and shorts.

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