LOCAL MARKETING AND FINANCING OF COTTON CROP United States.—The early financing of the American crop varies greatly with the method of agricultural tenure. In many cotton States the cultivation is carried out by "croppers" or "renters"—poor agriculturists, often negroes—who run and work small farms but who are merely tenants and who are provided with a part or a whole of the capital for running expenses by the owners. At harvest the value of the crop is divided between owner and cropper. In this case the standing crop is, therefore, financed by the owner, who will probably have recourse to his local bank. Where farms are run by independent tenants or owners any one of a group of middlemen may assist in providing capital. Factors may advanet money to the grower whilst the crop is still green in exchange for a lien upon it ; when the crop is harvested it is shipped direct to the factor who sells it on commission, so that the effect is to throw the risk of low prices upon the grower him self. Factors, according to the best authority, are declining in numbers and importance and the work of finance is now taken, to a great extent, either by country merchants with the help of the banks or by the country banks themselves. The country cotton merchants can guarantee themselves some share in the new crop by supplying the grower, in kind, with many incidental needs throughout the growing season, in return for a lien note upon the crop. When the crop is ripe the merchant accepts payment in kind. Or the country banks may advance funds directly to the grower on the security of crop notes. The extent to which the banks are willing to accept and discount the only security which the grower can offer, his future, even unsown crop, will largely determine the acreage devoted to cotton. The credit which the banks are willing to extend is theref ore one of the determining factors in the size of the crop.
The movement of the cotton after ginning may be most con veniently summarized in the form of a diagram to which, in actual practice, there may be numerous exceptions, but which gives the most common marketing process.
Ginning.
Country merchant in small town. Agent, from nearest big town, of firm owning compresses and warehouses. Cotton buyers and shippers.
Mill brokers in the United Importers in Liverpool, States ' cotton industry. Le Havre, etc.
In actual practice, the cotton buyers and shippers, who are large wholesale dealers, may deal directly with the farmer or with the country merchant, and eliminate the supply merchants in the big towns. Or the country merchant may be omitted and the grower deal directly with the wholesale agent, though this is less common.
From time to time complaints have been made by growers in the United States that the existence of a large group of middlemen arid merchants, often having a financial interest in the standing crop, places an onerous burden upon them. It has been alleged that the merchant, by reason of his own strong bargaining position and the relatively weak position and disunion of the growers, has been able to exact excessive rates of interest, and to impose his own conditions with the services that he renders. This belief and the hope that the substitution of direct bank credit for merchant credit will produce economy, have provided the stimulus to the growth of co-operative associations among growers. It certainly appears that such associations could do useful work in creating price stability by allowing the cotton crop to come upon the mar ket gradually throughout the year instead of with the annual ebb and flow that occurs under present conditions. But how far the associations would restrict themselves to actions such as this which may be justified economically and how far they might be tempted to use their power in the abnormal raising of prices, ex perience alone will show. At the moment co-operative marketing by growers is still largely in the stage in which the results of ex periment must decide future action.
The financing of the American crop from the time it leaves the grower's hands is a gigantic operation demanding enormous capi tal. Even if cotton is so low as is. per lb. and with a crop of m,000,000 bales the total value is L250,000,000. The task of carrying this crop could hardly be undertaken by the large whole sale merchants but for the credit which the banks provide. The help which they give has been much increased in recent years. Some mention has already been made of the part played by local banks in local financing of merchants or growers. Before 1913 the local banks were accustomed to grant credit either by open over draft or upon the security of crop notes. The banking system of the United States in those days was unsatisfactory, since it lacked both the restraining power of centralized control and the elasticity and capacity to withstand stress which comes with uniform policy. Such extension of credit was, therefore, not without its dangers. In 1913, however, by the establishment of the Federal Reserve banking system the safety of banking methods was much increased and the possibility of granting cotton credits, without fear of local strain or insolvency, established. The local banks, provided they are in the "system," are knit together with the Reserve banks and the policy of overdrafts has largely been replaced by the method of discounting merchants' papers.
Egypt.—The Egyptian cultivator may dispose of bis cotton in any one of a variety of ways. Some growers sell to travelling dealers and thus rid themselves of the trouble of transport to the market. Most of the cotton, however, is taken by the cultivator to either one of two classes of markets. Certain markets are par tially under Government control and supervision. These "halagas" —as they are termed—are merely large enclosed spaces sur rounded by stores in which cotton brokers will rent space, take cotton as it arrives from the fields and sell it for the owner upon a commission basis. Where the market is managed by a private individual or, as is often the case, either by the local bank or gin ning company, it is described as a "zarbieh." The grower, natu rally, very much prefers to deposit his cotton at one of these local markets, since it enables him to obtain an advance upon the secur ity of his stock either from the local merchant or banker and then, should prices be unfavourable, to hold back the cotton to a more opportune moment.
As is the case in the United States the growing crop is financed by capital other than that of the grower. Once the latter has deposited the seed cotton at the ginnery, he may, by obtaining a factory warrant for the cotton deposited, draw upon the bank for a certain proportion of the probable value of his crop. But even during the growing season, the interior merchants, either in specie or kind, and the banks, through financial accommodation, draw to themselves a large share of the capital burden.
There are two methods of purchase from the cultivator. The bulk of the annual crop is bought at a fixed price, since the aver age grower is not anxious either to run risks or engage in specu lative activity. The second method of "on call" purchase is one which appears to be growing and which is constantly being called into question particularly by spinners in England who believe that the element of speculation which enters into it is increasing the price at which they receive Egyptian cotton. It merits, therefore, some detailed explanation. Under the "on call" system the price at which the cotton passes is that of futures contracts for a given month in Alexandria with the addition or subtraction of a given number of "points" according to the quality of the crop purchased. The particular date taken for the fixing of the price is at the op tion of the seller, but a certain date, before which he must exer cise his right of choice, is fixed. To take a possible example : A buyer may agree in June to take the crop of a certain grower "on call," the price being fixed at futures contracts in Alexandria for the month of August plus ten "points on" that price in considera tion of the fact that the cotton being transferred is of a certain high quality. The seller may use his right, at any time, to "fix" the price definitely by choosing, at any time before or during August, that date on which he believes the prices of futures, for that month, to be at the peak. The effect of this operation is to trans fer to the grower greater discretion over the moment at which he will unload his cotton on to the market ; but it is obvious that this power, if used speculatively, may produce those oscillations in the price of the raw material which hinder and confuse the spinner.
After ginning and local sale the cotton bales are packed loosely and sent to Alexandria. Cotton destined for immediate export is then compressed and shipped, whilst that which is for sale on the home market is sent to the Minet-el-Bassal Spot Cotton Mar ket, from where most of it is sent abroad since very little cotton is consumed in Egypt itself.
The grower in India generally sells his seed cotton to the local shopkeeper, who mixes all the cotton which he receives in this way and sells it to up-country dealers, who in turn sell to ginners or exporters. The result is that the grower receives but a very small proportion of the final selling price. A more direct connec tion between the cultivator and the prices in open market is a pre-requisite for cotton-growing development. Only in the Cen tral Provinces and Berar is there general open market for sale; in most other centres there exists only a group of merchants who can largely impose their prices upon the grower.
Transference of Crop from Wholesale Dealer to Spinner. —The next stage to be dealt with is that by which the cotton finds its way into the hands of the spinner in Lancashire or else where. Here the description will be largely confined to details re lating to the American crop, but where the marketing processes of the Egyptian or Indian crop differ, these differences will be pointed out.
The new American crop begins to come into the market in August. The cotton merchants and importers in Great Britain, who are largely concentrated in Liverpool, may obtain their sup plies either by sending out their own agents to the United States where these agents will deal direct with wholesale merchants on the other side, or they may deal directly with American houses engaged in purchase and sale. At this stage the banks enter, both to provide the capital and to arrange for the transfer of funds be tween the parties to the transaction. The details of the manner in which they collaborate with buyer and seller is best explained by simplified example. Let us suppose that A in the United States despatches cotton to B, an English importer. A may, of course, either be the agent of B or an exporting merchant acting for any number of clients. A, after the cotton has been put on board ship, will take the bill of lading, marine insurance policy and a sterling draft on B or B's bank, to the amount of the value of the cotton, and sell it to his bank. A thus gets ready money and the task of collection devolves upon A's bank. A's banker then sends the documents and draft to England, where the sterling draft will be accepted by B's bank, which will continue to hold the bill of lad ing and insurance and which will probably be willing to accept the draft only upon condition that B hedges his purchase by selling futures—the precise significance of which action will be made clearer when the whole question of futures has been considered later. By this time the cotton has probably arrived in England. B will receive from his banker the bill of lading relating to the consignment together with instructions to warehouse the goods in the name of the bank. The usual practice is for B to acknowledge the receipt of the bill of lading and the instructioass in a trust letter. When the cotton is finally sold B pays to his banker suf ficient funds to meet the sterling draft when it becomes due and the commission charges which the bank demands for its services. There are often modifications of this system. A's banker may hold the draft until actual payment is made by B, but this method is not greatly favoured since it makes it necessary for the cotton to be held, on arrival, for A's banker, a procedure which involves trouble and time.
In some cases the spinner may buy his cotton direct from the ex porting house without any intermediate aid of the merchant. In such circumstances the cotton exporter draws upon the spinner or his banker, the draft is accepted by the bank and the docu ments handed over to the spinner so that he may gain possession of the cotton. This method is more commonly used, in Lancashire, in the purchase of Egyptian than in the purchase of American cotton. But, generally, the Lancashire spinner obtains his cotton through one or more intermediary agents.
The cotton may pass from the importer or merchant who is responsible for its arrival in this country to a selling broker, thence to a buying broker and finally to the spinner. The func tions of the buying broker are often very wide since he may ar range, as agent, not only for the purchase of all the cotton needed by the mills for which he is acting, but also for all the hedging operations into which the mills may deem it desirable to enter to avoid the danger of price fluctuations. This high degree of special ization and co-operation may be reduced, since merchant brokers are accustomed to import and either sell to their own spinners' clients direct or sell upon open market. The spinner may buy his spot cotton under several different types of contract, all of which are subject to the supervision and control of the Liverpool Cotton Association. The two most favoured methods are, how ever, purchase at "fixed price" or purchase "on call." Purchase at fixed price is self-explanatory and the "on call" method is based upon principles similar to those in operation in the sale of Egyptian cotton and described above. In any "on call" transaction the price is not definitely fixed as a money sum but as a certain number of points "on" or "off"—in the Liverpool Cotton Market a "point" is o o part of a penny and prices are always quoted in pence per pound—the price of futures for a given month. To take an example : If March futures are agreed upon as basis and the quality of the cotton desired by the spinner is so high that i 7o "points on" are arranged, then at any time before the end of March, the spinner may signify his desire to fix the price and com plete the transaction by obtaining delivery of cotton. The price paid for the cotton will be the price of March futures on the day at which the spinner decides to fix the price with the addition of the agreed number of "points on." The advantage of this method for the spinner is that when he enters into the "on call" transaction he safeguards himself against any undue rise in the price of the par ticular quality of cotton he desires, since the price is definitely linked with the price of futures by the fixing of "points on." Against movements in the prices of futures themselves he can only safeguard himself by hedging transactions to be described in the next section.
The differences between a spot contract in cotton and a futures contract are two. In the first place whereas the spot transaction is for the delivery of a specified type of cotton the futures con tract may be satisfied by delivery of any one quality of cotton within a range of qualities. It follows from this that the exact price at which cotton will pass from buyer to seller under a futures contract cannot be determined at the time when the contract is made. The futures contract is, therefore, a basis contract. The price of the contract is provisionally fixed on the assumption that an agreed standard quality of cotton is supplied. If anything in ferior or superior in quality is tendered in settlement of the con tract then subtractions from or additions to the provisionally fixed price are made. In the second place, the spot contract in cotton may either be for immediate delivery or delivery at some definitely specified time in the future, whilst the futures contract involves delivery of cotton on any one day within a prescribed period. Both in the determination of the exact quality of cotton to be delivered and the fixing of the day of delivery the seller has the right of decision.
It will be apparent, therefore, that futures contracts will be of little use to the spinner or broker in guaranteeing the supply of his raw material, since cotton tendered in futures contracts will be undetermined in quality or time of delivery at the time of the contract. The futures contract is, therefore, not used by the spinner or dealer to safeguard his future supplies of cotton ; it is used solely as a weapon whereby they may "hedge" themselves against the losses that may be occasioned through sudden and unforeseen changes in price.
Before the method used by the spinner or broker in buying or selling futures as "hedges" can be fully explained, something must be said of the actual form that a transaction in futures takes. Details of procedure vary between different organized markets though the principles remain the same. On the Liverpool Cotton Market each futures contract is for ioo bales of 500 lb. each. The terms "points on" or "points off" mean additions to or deduc tions from the provisionally fixed price of cotton delivered on the futures. A "point" is - per lb. of cotton. The Liverpool Cotton Market is organized and controlled by the Liverpool Cot ton Association. For the rapid settlement of transactions between the members of the Association on the market a highly organized system of working has been devised. The existence of a clearing house enables the diverse transactions outstanding between individ uals to be offset so far as possible and a final settlement produced with a minimum payment of cash of one to the other. The Cotton Bank, catering specially for members of the market, can similarly offset various credits and debits between two individuals and, by the use of book entries, reduce a complex mass of business to a money sum to be paid by one side or the other. In addition, vari ous groups of committees exist in the association to give rulings on prices, to arbitrate on qualities of cotton and generally to regulate the intermediary activities of cotton buying and selling.
Let us suppose that, on the Liverpool Cotton Market, A buys from B on Nov. i a futures contract in American cotton for the following March. B thus undertakes to deliver to A i oo bales of American cotton at some time within the following March. The quality of the cotton to be delivered will not be exactly specified but, according to the rules of the association and the special con ditions attaching to this form of contract, no cotton of less value than Low Middling can be tendered. The price to be paid for the cotton tendered is a price fixed on the assumption that cotton ranking as Fully Middling (Liverpool standards) will be delivered. The futures contract in Liverpool is a "settlement" contract. That is, the parties to the contract do not actually pay or receive the price of the futures but confine themselves to weekly pay ment or receipt of differences as the price of the futures oscillates. Let us further suppose that A had purchased the March contract from B for £2,500 on Nov. r. Then the differences paid can be shown by an example.
An Example of Futures Nov. r A buys March Futures from B for £2,500 Nov. 8 Price of March Futures has risen to £2,600—B pays A £roo Nov. r5 „ „ „ „ „ fallen „ £2,400—A pays B £2oo Nov. 22 „ „ fallen „ pays B £200 Nov. 29 „ „ „ „ „ risen „ £2,5oo—B pays A £3oo These settlement days occur on each Thursday on the Liverpool Cotton Market ; the prices at which settlement shall be made being fixed on the previous Monday. The settlements between A and B would, therefore, continue until the following March when B would have to deliver cotton on his contract. The "docket" authorizing A to accept the cotton would be passed in to him through the clearing house. But by this time it is very probable that A would have sold a similar futures contract to C and C to D. The docket would therefore be passed on to D who would receive the cotton and pay fox it the price provisionally fixed with "points on" or "points off" according to the actual type of cotton received. The transactions in futures between A, B and C would be settled without any cotton changing hands by means of the payment of differences.
This example shows that most people who have dealings in futures contracts do not anticipate having either to deliver or receive cotton. Their purpose is to use the futures to safeguard themselves against price changes and for this the receipt or pay ment of differences is sufficient. It also brings out clearly that the volume of futures contracts in any one year will be much greater than the total value of the crop which is made the basis for these contracts. Estimates differ, but the volume of trans actions in futures contracts in American cotton on all the organ ized markets of the world cannot be less than 20 times the actual value of the crop in any one year. The total value of futures contracts in Egyptian cotton is not less than ten times the total value of the crop.
The futures contract is used to provide a safeguard against price fluctuations. Thus a cotton importer who has bought cotton will sell futures contracts to approximately the same amount. There is, naturally, a close and sympathetic relation between the prices of "spot" cotton and the prices of futures. If, therefore, the price of "spot" cotton should fall the importer will lose from this decline, but his loss, to a more or less complete degree, will be offset by the fact that he has, in his futures contract, agreed to deliver cotton at a certain basis price; that basis price has now fallen and therefore, by the method of operation on the Liverpool Cotton Market, he will receive differences, as explained earlier. The spinner also uses the futures contract as a "hedge." If he has contracted to supply a certain amount of yarn at fixed prices at intervals in the future he will be anxious to prevent the possible loss arising through a general increase in the price of his raw material. If he buys futures contracts then a rise in the price of the particular type of cotton he requires for his yarn will be offset by the differences he receives from the seller of the futures. Within a wider margin a spinner might even "hedge" against possible falls in the price of yarn he may have in stock, for the movements of the prices of futures and yarn show broad simi larity, and, by selling the approximate number of futures, a fall in the price at which he will be able to dispose of the yarn will be offset by the fall in the price of futures involving the payment of differences to him.
By hedging in futures the spinner or importer foregoes the chance of gain through price fluctuations in order to insure him self against loss through such movements. But the degree to which this safeguard applies is limited. Perfect security is only provided assuming that the prices of different qualities of cotton move parallel to the price of the standard grade adapted for futures contracts. If they do not, if "points on" or "points off" vary for the same type of cotton from time to time then the spinner or importer is still subject, in a minor degree, to the risks of price movements. Thus if a spinner wishes to guarantee himself the supply of a certain grade of cotton for future delivery, he will buy futures contracts as a "hedge," but if the price of his "spot" cotton rises to a greater degree than the price of futures based upon Fully Middling cotton, then his loss will consist of the ex tent to which the prices of the two types of cotton have got out of step.
Up to this point only the individual who buys or sells futures as a form of insurance has been considered. In addition to such hedging transactions much speculative action is carried on by the members of the big organized cotton markets of the world. Such operations are, in large measure, necessary if the cotton markets are to provide continuous and stable conditions. It is the function of the speculator to take in the slack of either demand or supply when transactions in futures merely for the purpose of hedging create it. By his action in anticipating price movements and attempting to use these changes to his own advantage the price movements themselves will often be much reduced. But the justification of such speculative activity depends upon its being carried through by men of judgment, trained to a sense of the market and capable of weighing and interpreting the whole of the knowledge which bears upon the future.