COMMODITY TRADE

the international trade in primary goods. Such goods are raw or partly refined materials whose value mainly reflects the costs of finding, gathering, or harvesting them; they are traded for processing or incorporation into final goods. Examples include crude oil, cotton, rubber, grains, and metals and other minerals. Manufactured products, such as machinery and clothing, on the other hand, comprise products whose value reflects largely the cost of manufacturing processes. Such manufacturing processes contribute relatively little to the value of primary goods, which undergo little processing before they are traded. Commodities and commodity markets are terms used as synonyms for primary goods and the markets in such goods. the international trade in primary goods. Primary goods are raw or partly refined materials whose value mainly reflects the costs of finding, gathering, or harvesting them; they are traded for processing or incorporation into final goods. Examples include crude oil, cotton, rubber, grains, and metals and other minerals. Trade in commodities generally takes place in three related types of markets: the spot, the forward, and the futures market (the latter is also known as a commodity exchange). The spot market refers to the exchange of immediately or promptly available quantities of the good for immediate payment. The forward market refers to exchange of goods for money at some specified date in the future between specific contracting parties at a given price. The futures market refers to a special type of forward contracting market, modified to reduce risk and increase flexibility. Spot-market trading is probably the most flexible of markets. The contracting parties need not be in the same place, nor need delivery or payment take place in either location. These and other terms of the transaction, such as price, quantity, quality, condition, mode of payment, etc., can all be negotiated at the same time. Thus, current market conditions can be taken into account without difficulty. Forward contracting arose to address problems relating to very specific requirements in commodities, rapid price fluctuations, and uncertainties about quality. By allowing for future delivery at a given price and set of characteristics, both parties could ensure that those characteristics would be acceptable ahead of time. They would thus be able to plan their operations in the most efficient manner. The spot and forward markets together are called the actuals market, as opposed to the futures market. A futures exchange offers itself as a centralized trading place where contracts with standardized characteristics are traded by designated brokers. Compared to forward trading, futures trading is a compromise. In order to retain some of the flexibility of spot contracting, traders accept standardized contracts that differ only in price. For some traders, that is sufficient. However, most traders use the futures market to hedge, that is, to reduce risk due to fluctuating commodity prices in order to better use the spot or forward markets to obtain the actual goods. Hedging relies on the strong consistent linkage between prices in the spot or forward markets and those in the futures market for similar goods. Futures markets are especially common for commodities whose prices are relatively volatile and for which the required linkage between prices is an adequate approximation. Commodities markets subject to price-stabilizing influences such as those attempted by government pricefixing practices or monopolies tend to be less active since there is likely to be less price risk to hedge against. A crucial feature of international trade in commodities is that many undeveloped nations earn most of their export revenues from sales of primary commodities. They must use that revenue to finance whatever manufactured goods they wish to import. Thus the relative prices of the two types of goods are of great interest. Economists have coined the term terms of trade to characterize this ratio. The long-term trend and significance of the terms of trade are controversial; nevertheless, many underdeveloped nations argue that efforts to stabilize and raise prices in these commodities should be undertaken to improve the terms of trade. Efforts at price stabilization have frequently taken the form of stabilization boards that operate buffer stocks. These agencies buy up supplies when they are plentiful and sell them when they are scarce, with the effect of stabilizing the price of the good. If they succeed, not only are prices stabilized but they may be able to finance their operations from the funds generated from buying low and selling high. Unfortunately, that rarely happens for very long. In addition to the formidable difficulty of knowing when are the right times to buy and sell, these agencies are also characterized by high administrative expenses and are subject to powerful political pressures. As a result, they may even cause prices to be less stable than before. Eventually most attempts cease operations as they exhaust their funds. Other forms of stabilization that have been attempted, such as multilateral contracts and quota agreements, have had mixed results as well. Additional reading Bela Balassa, Trade Prospects for Developing Countries (1964); L. Baranyai and J.C. Mills, International Commodity Agreements (1963; originally published in Spanish, 1962); C.P. Brown, Primary Commodity Control (1975); Joseph D. Coppock, International Economic Instability: The Experience After World War II (1962), and International Trade Instability (1977); Simon Kuznets, Modern Economic Growth: Rate, Structure, and Spread (1966); M.A.G. Van Meerhaeghe, International Economic Institutions, 4th ed. (1985; originally published in Dutch, 1964); J.W.F. Rowe, Primary Commodities in International Trade (1965); and United Nations Conference on Trade and Development, Proceedings (irregular). Paul Wonnacott