Some of my friends and family like to give me a hard time about the evils of Wall Street, banks, and the financial industry. They like to argue they produce nothing physical and simply keep coming up with gimmicks and schemes.
When I point out that the stock market allows the raising of capital to launch and expand real business. Banks serve a similar purpose, especially in supporting small business. Usually after this they concede these points, but argue that derivatives are pointless, useless, and wasteful. That they are primarily tools for spectators.
The classic comeback is what about farmers, airlines, and insurance? Farmers benefit from futures contracts (and crop insurance). Airlines use futures and options to avoid getting pinched by rapidly rising fuel prices.
The classic retort is “Okay, maybe, but only consumers and producers should be able to participate; speculators should be excluded.”
My thought is who would take the other side of the trades? Who would take the other side of corn or oil futures contracts? Sure there would be a bit of action from oil producers and oil consumers, a bit of action from corn consumers (e.g. Kellogg’s). But the action would be thin, the spreads wide, and the trades few. Can you spell “illiquid”?
At which point my generic conversation partner tends to say something like “Don’t give me none of the financial gibber-jabber!”
But is it? I think not. I believe that commodities futures and options are potentially useful to producers (like farmers) and consumers (like Nestlé) and that “speculators” provide liquidity. I put “speculators” in quotes, to include not only speculators, but hedgers, investors, arbitrageurs, and market makers.
I’ve only begun to delve into this topic. To be continued…