Evening star. [volume] (Washington, D.C.) 1854-1972, 1908-05-04
WINNINGS FOR FEW
Smiths View of New York Cot
ton Exchange Methods.
EFFORT FOR "SURE THING"
Commissioner Of Corporations Re-
ports to President.
DECLARES SYSTEM UNECONOMIC
Says if Exchange Cannot Exist Un-
der Just System It Has No
Excuse for Existence.
DECLARES SYSTEM UNECON0MI'

Criticism of the methods of the New
York cotton exchange is made in a report
transmitted to the President today by
, Herbert Knox Smith. commissioner OF
corporations. The report is thus analysed
in Mr. Smiths letter OF transmittal:
1 have the honor to submit herewith
part 1 of the report on the operations of
cotton exchanges. made in accordance
. with House resolution No. 79o of Feb
ruary 4, 1867
This part deals with cotton exchange
methods of determining differences in
price between various grades of cotton in
connection with future contracts. Sub
sequent parts will take up the matter OF
classification of cotton. the range os
grades and effects of exchange rules and
other conditions upon the price.
Future transactions in cotton provide
for delivery at a distant date instead Of
for immediate delivery as in the case of
so-called spot transactions,
There are two great cotton exchanges
in this country. New York and New Or
. leans, where organized future dealings are
/. conducted All future trading on both
these exchanges is in sO-called basis
the delivery o: n number of grades OF
cotton on one contract. The seller of this
, contract may deliver thereon any grade
he chooses within the range prescribed by
! the exchange. The buyer has no option.
. The proper. theory of a basis contract,
. however, is that all grades shall be de-
. liverable at prices which will make them
. commercial equivalents of each other. Cot
. ton is graded substantially it's color
: and on the amount of leaf and other for
. eign matter, all materially affecting its
. market value. At the time that this in
: vestigatiOn started thirty grades were de-
iiVerable on contracts of the New York
Cotton Exchange. later reduced to eighteen
grades. chiefly by cutting out intermediate
. grades, with little reduction in the ex-
. IRENE range. The range of grades deliver
. able at New Orleans is nominally about
. the same. 'Middling'' cotton is always
the basis grade. the grade .or which the
. price Is fixed by the parties to the con-
tract The prices at which other grades
are deliverable are determined by the So
called differences" above and below-or.
in trade pariance, on and "off'-md-
. ding.
, Difference" Systems.
There are two ways of establishing
ii these differences. For the last eleven
. years the New York Cotton Exchange.
! has had a so-called fixed difference"
! system. committee of the exchange,
1 commonly known as the revision COM
: mittee, meets twice a year. in Septem-
: Der and in November and establishes
: the respective price differences on off
: which shall apply te the grades other
: than middling. These differences, once
established. cannot be changed until the
next regular meeting, and govern all
] contracts in futures.
! The New Orleans Cotton Exchange,
! on the other hand. has what known
as the commercial difference' system.
. y committee of the exchange meets
!. daily. and, upon information Of actual
!. spot transactions quotes tho rrIle s
!. of the various grades, which quotations
: virtually establish the differences which
: apply on future contracts. That is to
I. say, the New York system ARBITRARILY
: fixes what the differences for all grades
s shall be for two months or for Ten
| months, while New Orleans follows the
= actual market differences for these
grades as established by daily spot
transactions. This part compares these
!. two methods.
/. The buyer of future contract can
j. not specify the grades to be delivered
thereon. Obviously, therefore, he is
+ greatly concerned as to the differ
! ences' at which he may have to accept
j" the various grades. He knows exactly
the price for one grade-that is. mid
Z ding cotton That price was stipulated
in his contract. the so-calied basis price.
I. But as 70 the prices which he must pay
!. for other grades he is dependent upon
the exchange differences. The undeliy-
: ing principle of basis contract un-
!? doubtedly is that if the seller does not
8 deliver middling cotton he shall substi-
3 tute other grades only at their true
3 value relative to that of middlins i'll the
: spot market at the time of delivery
: that is, at the actual commercial DIFF
!. ferences. This clearly Is the only cqui-
!. table basis. Under these conditions. as
/. far price is concerned, basis future
:. contract is substantially the equivalent
!. of a contract for middling cotton. Con-
: sequently the market price of basis flu
ture contracts for immediate delivery
Z should be practically the same as the
: price of middling cotton in the spot
q market There is however, properly "a
8. small regular margin between the two.
Z because some expense Is 1nVoiVcd IN
:. sorting out and disposing of the mixed
!. assortment of grades likely to be re-
: ceived on contract.
Always a Risk.
!. Dealings in cotton must always be ac-
3 companied by risk, either to the producer.
!. the merchant middlenan, the SPECTATOR
!. or the spinner One special and necessary
: function of the Spectator in assuming
/. risk is to facilitate so-called "hedging''
: operations. The manufacturer of cotton.
: for instance. usually makes many months
: in advance his contract to deliver cloth to
: the dealer. His price for that cloth must
= be based largely on what he has to pay
3 for raw cotton This he cannot foretell
: Suppose he has agreed to deliver cloth
!. which will consume thousand bales Of
]. cotton, and at price which will be profit
!. able if he can buy that cotton at 10 cents
!. a pound Immediately upon making that
]. agreement he buys thousand bales on
: future contract. This contract should in
sure him against loss by fuctuatiOn in the
: price of raw cotton. For instance IL
when he buys his actual cotton for SPIN
ming the price of middling cotton has ad-
vanced to IL cents. he loses that much
: from his profit on the cloth. On the other
hand, if the price of future contracts has
made corresponding advance of cents.
o thus maintaining proper parity between
t the future price and the spot price, he
\ lmakes cents his future contract
= His loss on actual cotton is thus offset by
" his gain on the futures. His hedging Op-
= leration therefore. far from being specula-
/ tive. eliminates the speculative element
o from his business The manufacturer as
!. sumes sufficient risk in the risk of manu-
facture and distribution.
Similarly other interests. and particu-
" 1larly cotton merchants. thus try to hedge
Il against speculative risks.