Saturday, October 17, 2009

Money and Futures

A market where people buy and sell entities, which they do not own, is called a futures market. Futures markets exist for a number of commodities and for a variety of financial instruments. Such a market is legitimate for people who want to speculate on or hedge against future changes in price.

All participants in the futures market understand that the person who is promising to sell at a future date does not currently own what they are promising to sell. There is a risk that when they try to buy what they have agreed to sell; the price may have risen so high, that they cannot afford to buy so that they have to default on their agreement. Everyone in the market understands this risk.

Futures markets are inherently unstable, as prices can fluctuate rapidly and players default if unexpected events occur. This is fine, provided all participants understand the type of market they are operating in and a prepared to take these risks. However, this type of arrangement is not appropriate for a nation’s banking system, where stability is essential.

The modern banking system is essentially a futures market, where banks borrow short and lend long. Monetary regulators attempt to add stability to the market, but its nature is essentially unchanged. It is still a futures market.

1 comment:

Gene said...

This is pretty good. As a futures trader for a long time, I hadn't thought of Banks as futures traders.

Puts a whole different spin on it.