Comment by kqr
3 years ago
> A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Are you familiar with the arguments of (more popularly) Aaron Brown and (transitively) Jeffrey Williams?
Essentially, the idea that a farmer would be an active participant in a futures market is quaint, but the vast majority of activity is speculation. This is not a contradiction of your point, but an elaboration of a counter-intuitive part of it.
One might look at a futures market and see that well over 98 % of the activity is buying and selling by people who never have any reason to care about wheat other than for the possibility of its price going up or down. But this large-scale speculation is precisely the thing that makes it possible for a farmer to hedge (by providing liquidity and a motive for the counterpart of the hedge) or, as Williams' points out, perhaps more commonly "take out loans in commodities" for their convenience yield.
Essentially, the Lincolnshire farmer can lock in a price with a plain forward contract. However, that does take a double coincidence of demands (or whatever the phrase is) and the standardised nature of futures contracts help avoid that problem.
But! The most common use of futures contracts (aside from speculation) is not (or at least was not, when Williams wrote his book) hedging, but effectively borrowing and lending in commodities.
> the vast majority of activity is speculation
Where do you draw the line between (useful) arbitrage and "pure speculation"?
Much of what is commonly known as speculation is actually an important mechanism for price quality or liquidity.
Obviously there are limits, and there are ample opportunities for making a one-sided profit without regulations, but people often seem to miss the value that arbitrageurs tangibly provide to them: Being able to exchange foreign currency at very tight spreads almost 24/7; being able to buy and sell even not commonly traded stocks etc. are often a function of that.
I think you and I are saying the same thing! What's counter-intuitive about many well-functioning markets is that the vast majority of what happens is superfluous in one sense, but its side effects are desirable by most!