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July 08, 2008
Politicians Make My Eyes Tear Up
Don Boudreaux
From today's Wall Street Journal:
As it happens, though, there's a useful case-study in the relationship between futures markets and commodity prices: onions. Congress might want to brush up on the results of its prior antispeculation mania before it causes more trouble.
In 1958, Congress officially banned all futures trading in the fresh onion market. Growers blamed "moneyed interests" at the Chicago Mercantile Exchange for major price movements, which could sink so low that the sack would be worth more than the onions inside, then drive back up during other seasons or even month to month. Championed by a rookie Republican Congressman named Gerald Ford, the Onion Futures Act was the first (and only) time that futures trading in a specific commodity was prohibited, and the law is still on the books.
But even after the nefarious middlemen had been curbed, cash onion prices remained highly volatile. In a classic 1963 paper, Stanford economics professor Roger Gray examined the historical behavior of onion prices before and after the ban and showed how the futures market had actually served to stabilize prices.
The fresh onion market is highly seasonal. This leads to natural and sometimes large adjustments in prices as the harvest draws near and existing inventories are updated. Speculators became the fall guys for these market forces. But in reality, the Chicago futures exchange made it possible to mitigate the effects of the harvest surplus and other shifts in supply and demand.
To this day, fresh onion prices still cycle through extreme peaks and troughs. According to the USDA, the hundredweight price stood at $10.40 in October 2006 and climbed to $55.20 by April, as bad weather reduced crop yields. Then it crashed due to overproduction, falling to $4.22 by October 2007. In April of this year, it rebounded to $13.30.
Futures trading can't drive up spot prices because the value of futures contracts agreed to by sellers expecting prices to fall must equal the value of contracts agreed to by buyers expecting prices to rise. Again, it merely offers commodity producers and consumers the opportunity to lock in the future price of goods, helping to protect against the risks of future price movements.
Posted by Don Boudreaux in Energy, History, Prices, Regulation | Permalink
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Comments
Well explained! I've been reading Martin Stopford's "Maritime Economics" (2ed. Book) and the analysis provided here helps me to better understand Stopford's explaination of the spot market!
In the context of the shipping market, buyers are shipper's (onion farmers/consumers), and sellers are the ship owners that transport the onions. The spot market, in such a context, allows shippers to buy charters ahead of time, "on-the-spot". The spot market also allows ship owners a way to mitigate uncertainty by offer charters in advance of the volatile seasonality of agricultural transport.
Again, Well Done. And, Thank you.
Posted by: RKP | Sep 5, 2008 4:58:41 AM
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