Price Effects of a Lack of Speculation

The theoretical proposition that profitable speculation is pricestabilizing is not subject to direct empirical testing in the context of commodity futures markets. The reasons for this are twofold: (1) if all commodity futures trading is viewed as speculation, then this is a zero-sum game which moots the question of profitability; yet (2) if only that trading which is classified as speculation, in contradistinction to hedging, be considered, then the stabilizing effect is seen to be indirect, since it is the hedgers who perform the relevant temporal reallocation of stocks. Evidence of the price effects of speculation in commodity futures contracts is therefore sought in terms of the facilitation of hedging. A convenient and important case is provided by the three active American wheat futures markets-at Chicago, Kansas City, and Minneapolis. It is demonstrated here that the two latter markets, with low levels of speculation, are able to absorb the hedging positions which come to them only because substantial speculation is transfused from Chicago, through spreading. Evidence is also adduced to show that this spreading responds directly to hedging pressures, instead of reflecting price forecasts. Vocational speculation, by floor members of the commodity exchanges, also reflects the anticipation of hedging requirements. Although the data do not allow direct estimates of hedging costs, they strongly support the conclusion that these costs are lower on those markets having more speculation. The conclusion as to the price effects of speculation in commodity futures is then that with ample speculation there is no price effect, whereas the price effect of speculative deficiency is substantial.