The Wall Street Journal recently reported on widespread breaches of contracts for cotton resulting from extreme volatility in the cotton market since 2010. This has led, in turn, to losses on corresponding futures contracts used for hedging and to increasing distrust and litigation along the cotton supply chain. The article points out that cotton generally changes hands seven times "from seed to sweater."
When the binding nature of contracts erodes, it not only unsettles the market for the commodity involved, but also reduces the value of related futures contracts for hedging risk and discovering prices. Futures contracts are intended to reflect consensus concerning the likely fair market value of a commodity at some given time in the future. To the extent that value is determined through arbitration and litigation, it does not reflect the price set by a willing buyer and seller not under compulsion and with reasonable knowledge of market factors. Although exchanges and commodity associations have enforcement mechanisms available to them, such as barring defaulting parties from use of the market or association, these mechanisms will not, in themselves, restore order to the market because of its vast size and complexity.
The current situation with the cotton market underscores the limitations of any system of market supervision and regulation. Only mutual trust and respect for contractual obligations can assure a functional market, regardless of how effectively markets are supervised and regulated.
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