Cotton train going from gin to compress
The Liverpool Exchange, under different names, has existed since 1841, having taken approximately its present form in 1870, in the attempts to stabilize conditions after the great speculative period which resulted from the American Civil War. The New York and New Orleans Exchanges were both organized the following year. The uniformity of rules and practices in the trade which resulted from the establishment of the exchanges have been of inestimable benefit to the industry and to the world, and this despite occasional abuses, which have usually been corrected as methods for correction have been evolved.
Spot Markets and Those
Which Deal in "Futures"
The New Orleans Cotton Market, and those of lesser cities, are largely spot markets, that is, the dealings which takes place in the Exchanges at those points involve the actual transferring of cotton which is on hand, or, at least, contracted for. The New York market deals preponderantly 22 in what are known as contracts for future delivery, or, in the language of the Exchange, "futures." The Liverpool Cotton Market is both a great "spot" cotton market, and a great "futures" market. The striking thing about these "futures" contracts is that but few of them are fulfilled by actual delivery.
The question then arises, what function is fulfilled by the New York Exchange that it should have such an important place in the cotton market? To the uninitiated the speculative features of the market have often served to condemn it, and at times of speculative fever, or of manipulation such as has occurred on one or two occasions, there has been public agitation calling for legislation against dealing in futures. Yet the New York Exchange performs a very definite and valuable service, and its trading methods have served to stabilize the whole industry, and to remove from it much of that very speculation which is frequently charged against the Exchange itself.
The justification of the Exchange is found in the fact that the futures contracts common on its floor afford the cotton merchant and manufacturer a chance to insure themselves against losses occasioned by fluctuations in the market. The method by which this is done is called hedging.
Why the Merchant
Must Hedge His Sales
For the cotton merchant, the situation as it develops is approximately this: buying, as he must, all grades and quantities of cotton, he may have an immediate market with the spinners whom he serves for only certain of these grades, and thus may have left on his hands a large supply of cotton of other grades which came to him in his purchases which he has no call for at the time. These "overs" are subject to the risk of a decline in value unless the merchant can find some way to protect himself. Nor is this risk the only one run by the cotton merchant. The spinners frequently contract for months ahead for the output of their mills, and it is part of the merchant’s task to see that the cotton is available at a contract price when the spinners are in need of it. Such contracts for future deliveries are not only common but customary. If it were impossible for the spinner to make such contracts, it would, of course, be impossible for the weaver to make future contracts for the delivery of cloth. Such a condition unsettling the distributing markets, would be intolerable. Hence, the necessity of future contracts between merchants and spinners. The situation would otherwise be a very difficult one for the merchant whose supply of cotton, and the price he must pay for it, are subject to the vagaries of nature, which may grant a bountiful crop one year, and a short and inferior one the next, with consequent fluctuations in price sufficient not alone to wipe out his profit but his capital as well.
The Hedge As a
Credit Transaction