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
Hedging, as has been said, affords the protection, against serious loss
which these varying conditions make probable.
"It may almost be said," observes Arthur R. Marsh, former President of
the New York Cotton Exchange, "that as the main business of banks today
is not dealing in money, but in credits, so the main business of the
cotton exchanges is now in credit transactions in cotton, toward which
the actual cotton 'on the spot' stands in much the same relation as the
money in the banks to the sum total of their transactions in credit. It
serves as a reserve at once for the satisfaction of unliquidated credit
balances and for the maintenance of sound credit values in all the credit
operations."
Elsewhere, Mr. Marsh describes the hedging process in these words: "A
hedge is the purchase or sale of contracts for one hundred or more bales
of cotton for future delivery, made not for the purpose of receiving or
delivering the actual cotton, but as an insurance against fluctuations in
the market that might unfavorably affect other ventures in which the
buyer or seller of the hedge is actually engaged."
[Illustration: _The floor of the New York Cotton Exchange_]
How Merchants Secure
Protection by Hedging
The cotton merchant, in making a hedge, would proceed in this fashion.
Having made an actual sale of cotton to a spinner for future delivery,
the price being fixed according to current quotations in New York for
deliveries to be made in the month specified in the contract, he would
buy futures for a corresponding amount of cotton on the New York Cotton
Exchange.
If the price of cotton should have advanced when the time for the
delivery of the actual cotton comes, he will be able to sell his futures
contract at a higher price, thus offsetting the loss sustained upon the
deal in actual cotton. Or, if he prefers, he may hold the "
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