| Impact on The Economy |
| Written by Aaron Adam | |
Optimal conditionsAccording to the general consensus among economists, in a competitive market economy, the following conditions are optimal: many buyers and sellers trading openly, with no one group or individual controlling the market for one good; a standardized commodity, so there are no varying degrees of quality; free entry for buyers and sellers and full disclosure of products' supply and demand.There's no market that meets these conditions ideally, but the futures market actually comes closer than many other types of markets. Because the futures market is so very competitive, it provides three crucial economic benefits: an efficient means of determining a commodity's price level; the opportunity for producers to hedge for risk by passing it on to investors, thus lowering the cost of doing business and lowering prices for consumers; a clearing house of the dissemination of important market information. In the free market system, buyers and sellers of commodities determine the prices for these goods via the deals they make in the market. These prices are generally determined by the buyers and sellers estimates of the supply and demand for the product. Price discoveryPrice discovery is how the figure at which a buyer will buy and a seller will sell a futures contract is arrived at. In active futures markets, price discovery occurs throughout the trading day. This is good for the overall economy because it gives various actors in the economy up to the minute data concerning the perceived supply and demand for a product.Futures markets provide a great opportunity for price discovery because their high volume and minimal transaction costs encourage wide participation, thus reducing the opportunity for just one investor or a small pool of investors to obtain control of the commodity. Because futures prices are determined by a free and competitive market, they're considered to be a superior means of price discovery. Futures markets also meet other requirements for an optimal market in that futures contracts are generally standardized, so there's no differentiation in product quality. Hedging against riskProducing commodities involves risks for entrepreneurs involved with this task. Weather, geopolitics, legal disputes, natural disasters and other calamities can befall producers. There's no method of entirely eliminating this uncertainty, but the futures market provides a mechanism for producers to limit their risk through hedging.Hedging allows producers to limit their risk of loss by stretching the market period, protecting inventory values and permitting the forward pricing of products. Producers insure their profits through futures contracts by locking in a price that they'll be guaranteed to be paid at the delivery date regardless of current market prices. By creating a mechanism to hedge against risk, futures markets create an atmosphere that lowers the cost of doing business, thus lowering costs to consumers, creating more market activity and economic growth. Futures markets also provide benefits to the overall economy by providing timely and accurate information regarding supply, demand and pricing. In an active futures market, the volume of trades executed creates an enormous amount of information regarding commodities. In fact, futures exchanges often become clearinghouses for information regarding storage, purchases, imports exports, interest rates, and other important information. This can help determine the best estimate of prices regarding various commodities. This helps businesses make better decisions about purchases, expansion, cost estimates and employment. Growth in futures tradingFutures trading is becoming steadily more popular among investors as electronic trading has made it more accessible and the various benefits to investors, such as low margin requirements draws more people into the game.While futures trading has its beneficial aspects, the criticism of futures trading does have a kernel of truth. Speculative trading can contribute to unrealistically high and low prices and price gouging for important commodities such as food and energy. When speculative trading leads to unrealistic price information, it can cause shortages and dangerous surpluses of commodities. These occurrences are rare, however, and the overall beneficial nature of futures trading far outweighs the negative aspects of these investments. |
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