142 A ‘TREATISE ON MONEY oer enough to effect the absorption of stocks within a reasonable period). Where’ there are large stocks, a restriction of new production must be brought about somehow—sither by so greata fall of price as to com, Testriction, or by an organised voluntary restriction which will bring about the same result with a less fall of price. There can be no doubt, in such cases, of the advantage to producers of a policy of organised resivie, tion, “Such a policy only becomes dangerous if the Price level aimed at is too high in relation to normal Production costs, or if the producers, who join the “scheme of restriction, do not account for a sufficient proportion of the total capacity for production (as actually happened in the case of the Rubber Resttiction).! (v.) Tue Dusony or ti “Forwarp Manxer” Let ine restate the argument In terms of the “forward market”. In the case of organised markets for staple raw materials there exist at any time two Price-quotations—the one for immediate delivery, the other for delivery at some future date, say six months henee.t Now if the period of production is of the order of six months, the latter Price is the one which matters to a producer-considering whether he shall extend or curtail the scope of his operations ; for this is the price at which he can at once sell his goods forward for delivery on the date when they will be ready. If this price shows a profit on his costs of production, then he can go full steam ahead, selling is product forward and running no tisk. If! on the other hand, this’ price docs not cover his costs (even alter allowing for what he loses by temporarily laying 2 On the other hand, rubber presented eae ul . . - . , 7 ag LIQUID CAPITAL . M3 up his plant), then it cannot pay hin to produce E all, . If there are no redundant liquid stocks, the spot price may exceed the forward price (i, in the language of the market there is a “ ‘baclorardtion ”), If there is a shortage of supply capable of being remedied in six months but not-at once, then the spot price can tise above the forward Price to an extent which is only limited by the unwillingness of the buyer to pay the higher spot price rather than postpone the date of his purchase, When the buyer has himself entered into forward contracts as a result of having previously mis- calculated the state of supply, he may be compelled to pay a very substantial premium. Tt would be easy to quote cases where the backwardation for periods of three months has risen to the equivalent of 30 pet cent per annwn, . But it is not necessary that there should be an abnormal shortage of supply in order that a back. wardation should be established. If supply and demand are balanced, the spot price must exceed the forward price by the amount which the producer is ready to sacrifice in order to “ hedgo” himself, ie. to avoid the risk of price fluctuations during his ‘pro: duction period. “Thus in normal conditions’ the spot price exceeds the forward price, i.e. there is a beck Wardation. In other words, the normal supply price on the spot includes remunetation for the risk of price fluctuations during the period of production, whilst the forward price exchides this. The statistics of organised markets show that 10 per cent per annum * is a modest estimate of the amount of this back- wardation in the case of seasonal crops which have 4 production period approaching a year in length and are exposed to all the chances of the weather. In: less organised markets the cost is much higher—so high indeed as to be prohibitive to most producers, who prefer to.run the price risk themselves rathe:Mt . A TREATISE ON MONEY pew than pay it, It'will be soon that, under the present régime of very widely fluctuating prices for individual commodities, the’.cost of insurance against price changes—which is additional to any charges’ for interest or warehousing—is very high. ‘What is the position in the case important to the argument of this chapter, namely where there exist redundant liquid stocks? In this case there cannot exist. backwardation ; for if there was one, it would always pay to sell the stocks spot and buy them baci forward rather than incur the warehousing and interest. charges for carrying them during the intervening Period, | Indeed the existence of surplus stocks must fe to establish, in the language of the matlot charges of carrying the stocks. But the existence of picontango does not mean that a producer can hedge himself without paying the usual ingurance agaict Price changes. On the contrary, the additional elemeat of uncertainty introduced by the existence of stocks and the additional supply of risk-beating which they Tequire mean that he must pay more than usual In other words, the quoted fonvard price though above the- present spot price, wiust fall below the anticipated future spot price by at least the amount of the normal backwardation ; and the present spot Price, since itis lower than the quoted forward price, must be much lower than the anticipated future spot Brice. If the stocks are expected to be absorbed within 0 year, the present spot price must fall (say) PO PEr cont below the anticipated future spot pricey but if the stocks look like lasting for two jears then the present spot price mus fall (say) 40 per cent \ en. 29 LIQUID CAPITAL us (vi) Concruston This has brought us back to our former argument. Ossing to the existence of high earrying charges of one Kind or another, our present economic arrangements make no normal provision for looking after surplus liquid capital. If, as the result of a previous mis- caleulation, such stocks come into existence, the price of the goods continues to fall until either consumption increases or production falls off sufficiently to zbsorb them. In no case can surplus stocks exist alongside of normal production. Recovery—broadly speaking cannot begin until stocks have been absorbed, with the result that the process of recovery cannot be much. facilitated by the existence of stocks. ‘The conclusion of this section may be summarised by saying that our present economic system abhors a stock of liquid goods. If such a stock comes into existence, strong forces are immediately brought into play to dissipate it. ‘The efforts to get rid of surplus Stocks aggravate the slump, and the success of these eflorts retards the recovery. Incidentally it is evident that a fluctuation of 1 or 2 por cent in bank-rate will represent so small a part of the total carrying charges that it is not reason able to assign to the expense of high banke-rate 8 pre- ponderating influence on the minds of deslers in storks. tn $0 far a5 low and high bank-rate are regarded by dealers as symploms of impending rising or falling prices, it is another matter. But this influence will often tend to operate just the ‘wrong ay inducing them to increase stocks when trade is reviving an to reduce them when it is falling away. Thus the theory of Liquid’ Capital gives us, in relation to the swift downward movement of the slump, the counterpart of what the theory of Working Capital gave us, in relation to the slow upward move, You it on