If a drought kills off half the yield of hay in a given year, it's natural to expect the price of hay to double in the fall. On wider economies of scale , however, these shortages are not as easy to spot.
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That's why commodities speculators help to keep an eye on overall production, recognizing shortages and moving product to places of need and consequently higher profit through intermediaries—the middlemen who use futures contracts to control their costs. In this sense, speculators act as financiers to allow the middleman to keep supply flowing around the world. More than merely financing middlemen, speculators influence prices of commodities, currencies and other goods by using futures to encourage stockpiling against shortages.
Just because we want cheap oil or mangoes doesn't mean we should blame speculators when prices rise. More often, other factors, such as OPEC and tropical hurricanes, have raised the risk of a more volatile price in the future, so speculators raise prices now to smooth down the potentially larger future price. A higher price dampens current demand, decreasing consumption and prompting more resources—more people to take up mango growing or more funds for oil exploration—to go into increasing stockpiles.
This price smoothing means that, while you might not appreciate paying more for gas or a mango, you will always be able to find some.
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While people may recognize speculators' importance in preventing shortages and smoothing prices, very few associate speculation with guarding against manipulation. In markets with healthy speculation, that is many different speculators participating, it is much harder to pull off a large-scale manipulation and much more costly to attempt it and even costlier upon failing. Both Mr. Copper and Silver Thursday are examples of ongoing manipulations that eventually collapsed as more market speculators entered opposing trades. To avoid manipulation in markets we need more speculation, not less.
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In thinly traded markets, prices are necessarily more volatile, and the chances for manipulation are increased because a few speculators can have a much bigger impact. These mini-monopolies and monopsonies result in more volatility being passed on to consumers in the form of varying prices. Even when we leave the level of commodities and go into one of the largest markets in the world, forex , we can see how speculators are essential for preventing manipulation.
Governments are some of the most blatant manipulators. Governments want more money to fund programs while also wanting a robust currency for international trade. These conflicting interests encourage governments to peg their currencies while inflating away true value to pay for domestic spending. It's currency speculators, through shorting and other means, that keep governments honest by speeding up the consequences of inflationary policies.
See also: Forces Behind Exchange Rates.
The Futures: The Rise of the Speculator and the Origins of the World's Biggest Markets
Speculators can make a lot of money when they are right, and that can anger producers and consumers alike. But these outsized profits are balanced against the risks they protect those same consumers and producers from. For every speculator making millions on a single contract, there is at least an equal number losing millions on the trade—or a dollar on each of a million smaller trades. In very volatile markets, like those after a natural disaster or black swan event, speculators often lose money on the whole, keeping prices stable by making up the difference out of their deep pockets.
Taken cumulatively, speculation helps us far more than it could ever hurt us by moving risk to those who can financially handle it. Despite the misunderstanding and negativity speculators have to face, the potential for outsized profits will continue to attract people, as long as governments don't regulate them into oblivion.
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Emily Lambert. In The Futures, Emily Lambert, senior writer at Forbes magazine, tells us the rich and dramatic history of the Chicago Mercantile Exchange and Chicago Board of Trade, which together comprised the original, most bustling futures market in the world.
She details the emergence of the futures business as a kind of meeting place for gamblers and farmers and its subsequent transformation into a sophisticated electronic market where contracts are traded at lightning-fast speeds. Lambert also details the disastrous effects of Wall Street's adoption of the futures contract without the rules and close-knit social bonds that had made trading it in Chicago work so well.
Ultimately Lambert argues that the futures markets are the real ''free'' markets and that speculators, far from being mere parasites, can serve a vital economic and social function given the right architecture. The traditional futures market, she explains, because of its written and cultural limits, can serve as a useful example for how markets ought to work and become a tonic for our current financial ills.