The Raw Cotton Market
Because of the ramifications of the cotton industry, the cotton itself,
on its devious way from planter to consumer, is successively the concern
of a series of individuals and corporations. The immense value of the
product, the expense of growing, handling, manufacturing, and selling it
all mean that great quantities of capital are utilized in bringing it at
last to its final consumer. At any stage of the process, cotton
represents no inconsiderable part of the nation's wealth, and to expedite
its journey, merchandising and financial methods of a highly specialized
technique have been developed. There are two very clearly marked stages
in this process. The first has to do with the raw cotton, as it goes from
planter to mill. The second has to do with the journey from mill to
consumer. The first is usually called the Raw Cotton Market, and the
second the Cloth Market.
The planter begins his work early in the spring. His crop is dependent
upon his ability to secure and pay for the labor to work it, for the
tools and machinery which are used, and his own expenses. Small planters
are rarely sufficiently in funds to enable them to go through the growing
season without financial assistance. They must borrow money, and they
usually borrow it with the growing crop as a basis.
The Local Grower
And the Charge Account
They may borrow from the country merchant in the town near which their
plantations are located. Credit here is usually furnished through the
"charge account" system, whereby the merchant supplies the planter's
wants for the growing season, even to the extent of giving credit to his
farm hands. Tenant farmers live almost entirely on credit furnished by
the store-keepers of the vicinity. When the picking season begins, in
July, August, or September, according to the region concerned, the
merchant, in lieu of money, may take the cotton as it comes from the
gins, crediting the grower thereof at the market price. The cotton thus
accumulated is sold to local buyers, or, occasionally, to shippers or
exporters. In the case of the larger plantations, or groups of
plantations operated by syndicates or corporations, the cotton is
frequently shipped direct to the mill or, more often, to a warehouse. The
larger producers, instead of getting their credit from the local stores,
as their tenant farmers do, are financed either by their banks, or by
their buyers, who in turn are financed by their bankers.
The Street Buyers
Of Texas Towns
In some districts, particularly in Texas, there is the small or local
buyer, usually called a "street buyer," who operates in the smaller
towns, buying his cotton at the gins in lots of from one to ten bales,
either from the small planters, or from the country merchants. This
buying gives a certain concentration to the crop, and enables the larger
buyers to deal in lots of comparatively uniform quality from certain
regions, the general type of whose product is known.
[Illustration: _Street buyer in a Southern town_]
Cotton bought from the planters or from the country merchants is almost
invariably paid for in cash.
Cotton is frequently sold at the compress point, rather than at the gin,
this course being pursued in the case of large producers, or when the
original buyer is a mere local operator. One of the most important
operations, commercially as well as industrially, is the grading of
cotton, which takes place as a rule at the compress point under the
supervision of the buyer, who employs experts for this purpose. Cotton
mills as a rule operate on certain specified grades of cotton, and any
deviation from this grade means either a readjustment of machinery or
disgruntled and dissatisfied employes, or, perhaps, an inability to fill
an order for cloth of certain types. The manufacturer will usually refuse
to accept any grades save those he has specifically commissioned the
buyer to obtain for him. The actual grades, and the terms describing them
have been established by the United States Government, and are rigidly
adhered to by the trade. Prices are established on the grade known as
"middling" as a basis, and variation from this basis is taken up in the
price.
Standardization of
American Cotton Grades
The grades, for white cotton, as established by usage and confirmed by
Governmental standardization are:
Middling Fair Strict Low Middling
Strict Good Middling Low Middling
Good Middling Strict Good Ordinary
Strict Middling Good Ordinary
Middling
For yellow tinged stock the grades are:
Strict Good Middling Middling
Good Middling Strict Low Middling
Strict Middling Low Middling
For yellow stained and blue stained there are only three grades quoted,
good middling, strict middling, and middling, the inference here being
that stained cotton below the basic grade, is unsuited for most
commercial purposes.
With cotton selling around thirty cents a pound, the difference between
the cost per pound of middling fair, the highest market grade of white
cotton, and good ordinary, the lowest market grade, may amount to twelve
or thirteen cents. The value of the shipment, and its use as a basis for
credit, is dependent upon its proper classification.
The large cotton buyers purchase for the account of mills, for exporters,
or for clients abroad. They are usually firms of strong financial
standing, and as we have seen, they are bankers or factors themselves,
financing growers or small buyers during the growing of the crop, and the
first concentration of the cotton. But when the large movement of cotton
is on, it is frequently necessary that they, like the local banks, must
be financed in order that they may execute their orders, or, as is
frequently the case, accept cotton sent to them on consignment. Cotton
sent on consignment must be stored until a market is found for it, and in
order that proper storage facilities may be supplied, the provision of
suitable warehouse facilities is an important matter.
Warehousing as
Industry's Great Need
Until recently, warehousing in its relations to the textile trade, had
not been developed to the extent which might have been expected in those
methods which would make it of the greatest use and advantage to textile
interests. By means of the facilities which could properly be afforded by
warehouses, manufacturers, or merchants should be able, at times of
favorable markets, to lay in large stocks of materials, and to finance
them safely and easily.
Today, this need is being met in constantly increasing measure by the
Independent Warehouses, Inc., affiliated with the Textile Banking Co.,
and having, like the latter, the support of the Guaranty Trust Company of
New York, and the Liberty National Bank of New York.
Modern warehouses of approved type, with all requisite facilities, will
be established by this company at various ports of entry throughout the
country, as well as at the important concentration points in the cotton
belt, and also in the great textile manufacturing centers.
[Illustration: _Weighing cotton on the compress platform_]
Thus it is seen that the cotton merchant has an important economic
function to perform. His is the duty of gathering up the great aggregate
of cotton, from all parts of the cotton belt, and distributing it in
exactly the quantity and grade needed to the cotton manufacturers of the
world. In the performance of this function, and in order that the supply
of cotton may be fed out exactly as it is needed by the manufacturers,
the cotton merchants have found it convenient, and even necessary to
establish great common markets where they may meet and enter into the
transactions with each other and the whole world which are necessary to
bring the cotton into the channels of commerce and keep it moving to its
multitudinous destinations. These markets are in addition to the numerous
local markets where the preliminary concentration takes place, and to
some extent they are subsidiary to the latter, where the cotton of the
actual quantity and quality they are seeking is to be had in the first
instance. Yet it is the great markets which establish the prices, for it
is they which are in close and immediate touch with all the other markets
of the world, and it is on their floors that the merchants and brokers
meet who deal in great quantities. It is their connection with the
numerous sources of information which gives these great markets their
importance, for it is they which register immediately and most accurately
the resultant of the sum total of all the economic forces which
determine the price.
[Illustration: _The New York Cotton Exchange_]
The great cotton markets of the world are those of New York and New
Orleans, in the United States; Liverpool, in England; Bremen, in Germany;
Havre, in France; Alexandria, in Egypt; and Bombay, in India. There are
differences between these markets which give a greater importance to some
of them. Bremen, which serves a large territory, operates under
governmental restrictions which make it necessary for Bremen merchants to
deal in other markets as well. Havre serves chiefly the needs of France,
which is not one of the large cotton consuming countries. Alexandria
deals only in Egyptian cottons, and Bombay, whose dealings are confined
mostly to the native staples, has neither the responsiveness nor the
completeness of the remaining markets. Thus, by elimination, the three
great markets of the world, wherein cotton of all kinds is dealt in, and
all forms of transactions in it are common are those of New York, New
Orleans, and Liverpool. To these, the cotton world looks for guidance
from day to day. The prices established on their several floors are the
prices of the world.
[Illustration: _Cotton train going from gin to compress_]
The Liverpool Exchange, under different names, has existed since 1841,
having taken approximately its present form in 1870, in the attempts to
stabilize conditions after the great speculative period which resulted
from the American Civil War. The New York and New Orleans Exchanges were
both organized the following year. The uniformity of rules and practices
in the trade which resulted from the establishment of the exchanges have
been of inestimable benefit to the industry and to the world, and this
despite occasional abuses, which have usually been corrected as methods
for correction have been evolved.
Spot Markets and Those
Which Deal in "Futures"
The New Orleans Cotton Market, and those of lesser cities, are largely
spot markets, that is, the dealings which takes place in the Exchanges at
those points involve the actual transferring of cotton which is on hand,
or, at least, contracted for. The New York market deals preponderantly
in what are known as contracts for future delivery, or, in the language
of the Exchange, "futures." The Liverpool Cotton Market is both a great
"spot" cotton market, and a great "futures" market. The striking thing
about these "futures" contracts is that but few of them are fulfilled by
actual delivery.
The question then arises, what function is fulfilled by the New York
Exchange that it should have such an important place in the cotton
market? To the uninitiated the speculative features of the market have
often served to condemn it, and at times of speculative fever, or of
manipulation such as has occurred on one or two occasions, there has been
public agitation calling for legislation against dealing in futures. Yet
the New York Exchange performs a very definite and valuable service, and
its trading methods have served to stabilize the whole industry, and to
remove from it much of that very speculation which is frequently charged
against the Exchange itself.
The justification of the Exchange is found in the fact that the futures
contracts common on its floor afford the cotton merchant and manufacturer
a chance to insure themselves against losses occasioned by fluctuations
in the market. The method by which this is done is called hedging.
Why the Merchant
Must Hedge His Sales
For the cotton merchant, the situation as it develops is approximately
this: buying, as he must, all grades and quantities of cotton, he may
have an immediate market with the spinners whom he serves for only
certain of these grades, and thus may have left on his hands a large
supply of cotton of other grades which came to him in his purchases which
he has no call for at the time. These "overs" are subject to the risk of
a decline in value unless the merchant can find some way to protect
himself. Nor is this risk the only one run by the cotton merchant. The
spinners frequently contract for months ahead for the output of their
mills, and it is part of the merchant's task to see that the cotton is
available at a contract price when the spinners are in need of it. Such
contracts for future deliveries are not only common but customary. If it
were impossible for the spinner to make such contracts, it would, of
course, be impossible for the weaver to make future contracts for the
delivery of cloth. Such a condition unsettling the distributing markets,
would be intolerable. Hence, the necessity of future contracts between
merchants and spinners. The situation would otherwise be a very difficult
one for the merchant whose supply of cotton, and the price he must pay
for it, are subject to the vagaries of nature, which may grant a
bountiful crop one year, and a short and inferior one the next, with
consequent fluctuations in price sufficient not alone to wipe out his
profit but his capital as well.
The Hedge As a
Credit Transaction
Hedging, as has been said, affords the protection, against serious loss
which these varying conditions make probable.
"It may almost be said," observes Arthur R. Marsh, former President of
the New York Cotton Exchange, "that as the main business of banks today
is not dealing in money, but in credits, so the main business of the
cotton exchanges is now in credit transactions in cotton, toward which
the actual cotton 'on the spot' stands in much the same relation as the
money in the banks to the sum total of their transactions in credit. It
serves as a reserve at once for the satisfaction of unliquidated credit
balances and for the maintenance of sound credit values in all the credit
operations."
Elsewhere, Mr. Marsh describes the hedging process in these words: "A
hedge is the purchase or sale of contracts for one hundred or more bales
of cotton for future delivery, made not for the purpose of receiving or
delivering the actual cotton, but as an insurance against fluctuations in
the market that might unfavorably affect other ventures in which the
buyer or seller of the hedge is actually engaged."
[Illustration: _The floor of the New York Cotton Exchange_]
How Merchants Secure
Protection by Hedging
The cotton merchant, in making a hedge, would proceed in this fashion.
Having made an actual sale of cotton to a spinner for future delivery,
the price being fixed according to current quotations in New York for
deliveries to be made in the month specified in the contract, he would
buy futures for a corresponding amount of cotton on the New York Cotton
Exchange.
If the price of cotton should have advanced when the time for the
delivery of the actual cotton comes, he will be able to sell his futures
contract at a higher price, thus offsetting the loss sustained upon the
deal in actual cotton. Or, if he prefers, he may hold the "futures"
contract until its maturity and sell it at the then prevailing figure.
The first course would be the customary one for a bona-fide merchant,
whose sole concern is protecting himself against loss by fluctuations in
price.
If, on the other hand, cotton should fall before the merchant bought to
fulfill his actual contract, he would make a profit upon his sales to the
spinner. He would, however, suffer a loss upon his futures contract, for
the seller would be able to purchase the cotton to fulfill the contract
at a lower point than the contract called for, and would consequently be
able to deliver to the merchant who made the hedge, cotton which the
latter would be forced to accept at a price higher than the then
prevailing one, and thus again the profit and loss would balance each
other. The usual custom is, not for the merchant to accept delivery, but
to pay over to the seller of the futures contract the difference between
the contract price and that prevailing. This would be just the difference
between his own purchasing and selling price in his actual dealing with
the spinner, and so would eliminate the profit, due to change in price,
made in that transaction. Thus, by the hedging process, the merchant
loses a possible profit on a falling market, but at the same time fails
to suffer a loss when the market is against him.
Hedging as Practiced
By Cotton Manufacturers
The manufacturer's hedging is necessarily somewhat different in practice,
though the same in principle. If he accepts orders for cloth requiring
more cotton than is being held in his warehouse, he may buy futures
contracts to the amount of the additional cotton he will need. Then in
the event that his actual purchase of cotton may be at a figure which
would tend to reduce or eliminate his profits on the sale of the cloth,
already fixed by contract, he may sell his futures contract at a
corresponding profit, thereby preventing loss. Should the price of cotton
fall in the interim, his profit on the sale of the cloth will be larger,
but the settlement of his futures contract will be expensive to the same
extent. Thus he sacrifices the chance of a greater possible profit in
order to be insured against loss.
[Illustration: _Compress bales bound for New Orleans_]
It is probably more common for the cotton merchant to hedge than for the
manufacturer to adopt that proceeding. The manufacturer, as a rule, has
been accustomed to buy his cotton during the buying season, that is, in
October, November, December, and January, and he makes his arrangements
with his selling agents on the basis of the price paid, trusting to his
own judgment, and the comparatively small fluctuations in the price of
cloth in normal times, to protect him against loss. It is usually
believed that the Southern mills, being newer, and frequently of a
different financial standing, have found it more desirable to have
recourse to this form of insurance than their older competitors in the
North. Then, too, the rapid development of the cotton warehousing system
has made it less necessary for the manufacturers to tie their money up in
great quantities of cotton, as they can buy when the market appears
favorable.
Protection for Mills
Running for Stock
A very important point, however, and one which all manufacturers would do
well to consider carefully is the protection which a "futures" market
gives to a manufacturer making plain goods for stock, particularly on a
falling raw material market, which, of course, would also mean a falling
goods market. To stop the mill because values were falling would be
impossible without utter disorganization, and its attendant heavy loss,
while to keep on manufacturing stock goods with a certainty that they
would be worth less each succeeding month is a disheartening prospect for
the mill.
If, however, the manufacturer sells "futures" for the succeeding months
to the extent of the cotton which he would require each month to
manufacture the goods, he can run his machinery as usual and have a
perfectly free mind, as he has safeguarded himself against any loss due
to a falling value of the raw material. Suppose, for instance, the cotton
market fell off, say one cent a pound each month, with a corresponding
fall in the value of the woven goods. In such an event, the manufacturer
could, as each month arrived, buy a contract for an amount corresponding
to what he had sold, and at a proportionately less price, thus making a
profit on the "futures" which he had sold to an extent which would
correspond, approximately, to the smaller value which his manufactured
goods would then have in the market. Thus the profit on the one side
would take care of the loss on the other. If the market rose instead of
falling, he would make a loss in replacing his futures contract, but his
goods would then command a higher value, and again no loss would be
experienced.
This method of hedging is the regular and standard practice of the
English cotton mills, and, of course, of many of our domestic mills, but
there are some manufacturers who, through their unfamiliarity with the
operations of the futures market, are quite unaware of the protection
which they thus have at hand.
The Responsiveness of
the Great Exchanges
The great exchanges, and the New York Exchange in particular, are thus
used by cotton merchants and manufacturers in every part of the world to
protect themselves in their buying and selling operations. The value of
middling cotton in New York is kept upon par with the value of the same
cotton in any growing or manufacturing point, such factors as freight,
insurance, brokerage, etc., being allowed for in the quoted price.
Quotations on the Liverpool Exchange are thus higher than quotations in
New York by the difference between the amount it costs to deliver cotton
in Liverpool and to deliver it in New York. Thus the merchant and
manufacturer is able to buy and sell hedge contracts on the New York
Exchange, knowing that operations at the New York price in New York are
on a parity with operations at the Liverpool price in Liverpool, or at
the Havre price in Havre. Thus the hedge contract which a Southern
merchant sells in Atlanta, through his broker on the New York Exchange,
may be bought by a spinner in Tokyo or Manchester, anxious to insure his
supply of cotton at a price which would make his contracts profitable.
In normal times the selling of merchants and the buying of manufacturing
engaged in actual and bona fide hedging transaction has been estimated by
competent authorities to make up fully seventy-five per cent. of the
trading done on the New York Exchange. The remaining twenty-five per
cent. may thus be attributed to speculative operations, that is
operations entered into by outsiders through brokers, on the chance of a
rise or a fall in the market. Nor is such speculation without its value.
It is the speculators, as a rule, who are the first to take advantage of
crop reports or weather conditions, or news likely to affect the market
favorably or unfavorably, and buy or sell as their judgment dictates.
Their operations serve to discount such changes to some extent, or at
least to make the breaks and rises more gradual than they would otherwise
be.
In abnormal times, that is times of great scarcity and great demand, or
bumper crops and small demand, the speculative element plays a larger
part, for it is in such times that the greatest fluctuations in price
take place. Merchants or manufacturers holding hedging contracts are
under a greater incentive to buy or sell, as they see their opportunities
for profit growing greater or less, as the case may be, and in
consequence more contracts are made, and they pass from hand to hand with
greater rapidity, the gain or loss thus being distributed among a greater
number of persons than would otherwise be the case. It is the operations
of speculators, and the manipulation that once or twice during its
history has been possible by unscrupulous traders which has brought about
at such times public agitation for the abolition of the Exchange. Recent
changes in the form of the cotton contract have made it almost impossible
for such operations, if repeated, to be successful, and thus there is
little likelihood that the very important economic function of the
Exchange will be interfered with by legislation.