Monday, June 23, 2008

Hicks on Forward Markets, Speculators and Hedgers (fg)

Hi folks,

I just stumbled over a nice passage of J. R. Hick's Value and Capital on forward trading and speculators. Surprisingly, (at most for many people) he claims that it's the speculator driving future prices to reasonable levels whereas hedgers are the main root for distorted prices.

However, when reading the newspaper these days, the media rather makes the speculator (hedge funds, mutual and investment funds, conduits etc.) and his unruly capitalist ravenousness responsable for financial harm and misery. To them, poor hedgers have to suffer from the "Heuschrecken". So who is right? Media or Hicks? I think, you all know the answer:

If forward markets consisted entirley of hedgers, there would be a [..] weakness of the demand side. [..] for this reason forward markets rarely consist of hedgers. The future price which would be made by the transactions of hedgers alone would be determined by causes that have nothing to do with the causes ordinarily determining market price; it would be widely different from the spot price [..]. Future prices are therefore nearly always made partly by speculators, who seek a profit by buying futures [...]. Their action tends to raise the futures price to a more reasonable level [..]. The risks of price fluctuations in question [..] therefore, measures the cost of the co-ordination of plans achieved by forward trading. Hicks (1946, p. 137ff.)

As you can recognize, if prices can go up and down, there is a stabilizing force which comes from the speculator. Enduring expectations of price surges is the main concern! This is called a bubble and a bubble has to be financed with fresh money provided by central banks. Consequently, speculating itself is healthy for the co-ordination of plans. Unsustainable monetary policy not!