26 October 2009

Warren Buffett on financiers and derivatives traders

"If 50 of us were on a ship and there was a shipwreck, we all swam to an island, we knew we'd never be rescued - and fortunately it was a fertile island so we could all plant rice and grow enough to take care of ourselves. We would not take the five smartest people out of the 50 and tell them "why don't you start trading rice futures and speculate among yourselves", and by the way we think that's so valuable we're going to give you the most money and probably a favourable tax rate on top of it. Hell no, we'd get everybody producing rice."
More excerpts from his BBC interview at The Guardian.


  1. Buffet's quote is meaningless. It has no relevance to the state of the world. Of course if you were shipwrecked everyone would need to produce food otherwise there would not be enough food to survive. In subsistence farming on such a small scale because none of the goods are going to be sold, there is no need for hedging. Once the motive of profits come into play is when futures trading becomes important. Futures are there as a hedging vehicle for the producers and the consumers.

  2. Jacob, I agree with your last sentence (and the third and fourth ones, but not the others). My grandparents were farmers, so I'm quite familiar with grain futures etc, and I use options in my personal portfolio to decrease risk.

    What Buffet is referring to is not futures purchases/sales by producers and consumers, but trading for the sake of trading where ownership of the commodity itself is irrelevant. The ultimate in that regard is high-frequency trading, where the speculator is in and out in a matter of several milliseconds (http://tywkiwdbi.blogspot.com/2009/07/high-frequency-stock-trading.html).

    I know you can counter that such trading "makes the market," that it's a zero-sum game, and that it doesn't hurt anyone but the participants. Warren Buffett was probably answering a question re the relevance/importance of such trading, why he doesn't employ such tactics, etc. He's using a similie and hyperbole, which is why the quotation in your view seems not to be relevant to the state of the world.

  3. It's not true that ownership is irrelevant in many of the commodity contracts, because if they were held to expiration, either giving or taking delivery is required.

    High frequency trading provides liquidity, it is a very different way of trading than just speculating. And it does make the markets, without this kind of trading it would cost actual hedgers way way more to layoff their risk.

  4. Jacob, you are inadvertently hitting the nail on the head when you state that, "...without this kind of trading it would cost actual hedgers way way more to layoff their risk..." You are asking people who are not involved in the sale and use of the commodity to help assume the risk of its future cost. "Actual hedgers" get to "layoff their risk." Thus, when oil traders see the mirage of an impact on oil availability somewhere in the world, EVERYBODY gets to help hedge the risk. I can see this as a valuable proposition for the traders and speculators, but I think one condition should be written into every commodities contract: You buy it, you take delivery. You sell it, you have to deliver it. The ultimate price is stabilized by the market and the producer is protected. Of course a lot of commissions would be lost.

  5. @artful dodger
    having that condition would actually kill the commodities market. It's not just speculators that buy and sell contracts without taking or giving delivery on the product. Market makers, producers, consumers all buy and sell contracts without entering into delivery.
    You can't enter into a contract and then just not take delivery you have to then execute the other side to get out of delivery. So, anyone who buys a contract but does not want to take delivery then has to sell that contract.

    There is not just one kind of trader, and they all have different kinds of risks.

  6. Jacob, you keep making my point! Originally, the commodities market was made up of producers and consumers. Period. The price was stabilized and each party knew what the true cost would be. Now the producers, the "market makers," the speculators, the commission-earning brokers and the day traders all run around buying and selling to each other, each in the hopes of making a profit. Don't get me wrong. Profit is good. But just what is the "commodity" that is being sold when someone buys a "Spyder" or a Dow Futures contract? And show me how well the market worked on the commodity underlying the mortgage futures market. That was a real stabilizing influence wasn't it.

  7. You are missing the fact that all commodity contracts are based upon the underlying commodity. If the contract prices were not still based upon where the product can be bought and sold on the spot market coupled with future expectations, there would be no reason to trade different commodities or for example for crude oil and gold futures to have different prices.

    Each of the players you mention try to gain profits in different ways. Not all speculators play direction.

    Here is what the SP future is for an example

    The mortgage futures market just shows the risk involved in commodities trading. Securities trading did not cause the collapse in house prices, it was the other way around. There was rampant speculation in real estate partially due to an artificially low interest rate.

  8. Also having other players in the markets make it easier and cheaper for the both the consumer and the producer, whom the markets were originally solely made up of, to do what they want to do through added liquidity.

  9. "The mortgage futures market just shows the risk involved in commodities trading." No. it shows what happens when somebody decides there is a market for a "commodity" that doesn't exist. The mortgage market was stable until there was a way to take bad loans, package them and offer them as speculative plays. Suddenly, every guy with a plaid sport coat and a five year old Mercedes was out trying to convince 80 year old widows to take out loans at 100 times their income and triple their equity. The market sucked them up and more had to be made. When that market crashed, as it inevitably had to, the "liquidity" for the farmers and other producers dried up too. That's why the dairy farm down my road went out of business. Suddenly the bank couldn't lend any money to help them survive the drop in milk prices. The bank couldn't borrow money to lend. Liquidity had vanished (except for the cash those mortgage flacks had stuffed in their mattresses).

    I think we've kind of hijacked this thread, so this will be my last comment on this article.

  10. Then I will get the last word in :)

    Blame it on the government not commodity traders.

    There was a way to take bad loans because the banks were forced to write these bad loans.
    In addition to that people got caught up in a bubble partially caused by artificially low interest rates set by the Fed..

    Milk prices have plummeted in part because of extreme supply excesses. Which I would put at least part of the blame at the government's doorstop because of over-regulation and price floors. Basic economics that price floors will lead to excess supply.


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