Economists say that if American futures markets aren’t fixed, their use will diminish and farmers could lose the most honest price discovery mechanism they have.
“This is attacking a vital organ of U.S. agriculture and there’s a real danger of the patient going terminal,” University of Illinois economist Scott Irwin said about the Chicago Board of Trade’s soft red winter wheat contract.
“If the market died, I think we’d find out just how expensive the alternatives are for farmers, processors and ultimately consumers.”
For the wheat contract, economists at the University of Illinois recommend drastic changes to delivery points to force better convergence between the cash and futures markets, which at times since 2005 have been $2 US per bushel wide.
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North Dakota State University agricultural economist Bill Wilson, who has studied U.S. futures markets, thinks four main problem areas are leading to the lack of convergence:
- Outdated delivery points.
Many contracts were established when the crop industry functioned differently and have not been modified to reflect modern conditions.
As the University of Illinois study noted, most wheat now moves through New Orleans, but the CBOT’s contract uses Chicago and Toledo, Ohio, as delivery points.
If people can’t easily deliver or stand for delivery against a contract, there isn’t much ability to make prices converge.
- Increased volatility in all markets.
In wild times such as the last two years, sudden moves in the futures markets can take a long time, if ever, to make it through to the cash market.
- Different supply and demand fundamentals in the United States than what exists in the rest of the world mean Chicago prices and world prices can be far apart.
- Hedge and investment funds can cause futures prices to move in a complicated way that can’t easily be linked to the cash market.
The Illinois economists recommend to the CBOT and Commodity Futures Trading Commission that the delivery point for Chicago wheat become New Orleans, from which most of that type of wheat is exported.
That way, big flows of grain can force convergence and provide real price discovery. If that doesn’t happen, new price discovery mechanisms could arise, but that might be like reinventing the wheel.
“If this (problem) persists, another market could spring up that works better,” Irwin said.
“That’s not necessarily a bad thing, but it’s better to fix the one that’s here, one that’s large and well established.”
