To understand the concept of a commodity, consider a chair. It is a commodity if the chair is a tradeable product of human work possessing a social use-value. By contrast, a fallen log of deadwood sat upon in the forest is not a commodity, as it was not produced by human work for the purpose of trade. A chair created by a hobbyist as a gift to someone is not a commodity. Nor is a chair a commodity (as a chair) if its only use would be as scrap firewood (unless one purchases a chair specifically to chop it up for fire wood). A chair that nobody could sit on has no use-value, and cannot be a commodity (unless it has an ornamental value, e.g. in a doll's house).
Commodity market
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.
This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals, electricity) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets.
See List of traded commodities for some commodities and their trading units and places.
The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets. For a commodity market to be established, there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another.
The economic impact of the development of commodity markets is hard to over-estimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade."
Historically, dating from ancient Sumerian use of sheep or goats, or other peoples using pigs, rare seashells, or other items as commodity money, people have sought ways to standardize and trade contracts in the delivery of such items, to render trade itself more smooth and predictable.
Commodity money and commodity markets in a crude early form are believed to have originated in Sumer where small baked clay tokens in the shape of sheep or goats were used in trade. Sealed in clay vessels with a certain number of such tokens, with that number written on the outside, they represented a promise to deliver that number. This made them a form of commodity money - more than an "I.O.U." but less than a guarantee by a nation-state or bank. However, they were also known to contain promises of time and date of delivery - this made them like a modern futures contract. Regardless of the details, it was only possible to verify the number of tokens inside by shaking the vessel or by breaking it, at which point the number or terms written on the outside became subject to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets. This represented the first system of commodity accounting.
However, the Commodity status of living things is always subject to doubt - it was hard to validate the health or existence of sheep or goats. Excuses for non-delivery were not unknown, and there are recovered Sumerian letters that complain of sickly goats, sheep that had already been fleeced, etc.
If a seller's reputation was good, individual "backers" or "bankers" could decide to take the risk of "clearing" a trade. The observation that trust is always required between market participants later led to credit money. But until relatively modern times, communication and credit were primitive.
Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness. Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers of kingdoms along the trade routes, it was a major focus of these civilizations to keep markets open and trading in these scarce commodities. Reputation and clearing became central concerns, and the states which could handle them most effectively became very powerful empires, trusted by many peoples to manage and mediate trade and commerce.
Commodity and Futures contracts are based on what’s termed "Forward" Contracts. Early on these "forward" contracts (agreements to buy now, pay and deliver later) were used as a way of getting products from producer to the consumer. These typically were only for food and agricultural Products. Forward contracts have evolved and have been standardized into what we know today as futures contracts. Although more complex today, early “Forward” contracts for example, were used for rice in seventeenth century Japan. Modern "forward", or futures agreements, began in Chicago in the 1840s, with the appearance of the railroads. Chicago, being centrally located, emerged as the hub between Midwestern farmers and producers and the east coast consumer population centers.
"Hedging", a common (and sometimes mandatory) practice of farming cooperatives, insures against a poor harvest by purchasing futures contracts in the same commodity. If the cooperative has significantly less of its product to sell due to weather or insects, it makes up for that loss with a profit on the markets, since the overall supply of the crop is short everywhere that suffered the same conditions.
Whole developing nations may be especially vulnerable, and even their currency tends to be tied to the price of those particular commodity items until it manages to be a fully developed nation. For example, one could see the nominally fiat money of Cuba as being tied to sugar prices, since a lack of hard currency paying for sugar means less foreign goods per peso in Cuba itself. In effect, Cuba needs a hedge against a drop in sugar prices, if it wishes to maintain a stable quality of life for its citizens.
In addition, delivery day, method of settlement and delivery point must all be specified. Typically, trading must end two (or more) business days prior to the delivery day, so that the routing of the shipment (which for soybeans is 30,000 kilograms or 1,102 bushels) can be finalized via ship or rail, and payment can be settled when the contract arrives at any delivery point.
U.S. soybean futures, for example, are of standard grade if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Indiana, Ohio and Michigan origin produced in the U.S.A. (Non-screened, stored in silo)," and of deliverable grade if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Iowa, Illinois and Wisconsin origin produced in the U.S.A. (Non-screened, stored in silo)." Note the distinction between states, and the need to clearly mention their status as "GMO" ("Genetically Modified Organism") which makes them unacceptable to most "organic" food buyers.
Similar specifications apply for orange juice, cocoa, sugar, wheat, corn, barley, pork bellies, milk, feedstuffs, fruits, vegetables, other grains, other beans, hay, other livestock, meats, poultry, eggs, or any other commodity which is so traded.
The concept of an interchangeable deliverable or guaranteed delivery is always to some degree a fiction. Trade in commodities is like trade in any other physical product or service. No magic of the commodity contract itself makes "units" of the product totally uniform nor gets it to the delivery point safely and on time.