Let me try to explain it in a simplified way. An August 2009 futures contract is an agreement to provide a set product and a set quanity in August 2009.
Here is an example:
I have 1000 cows that will be ready for the market next August. I'm hoping the market will give me $1.00 a pound for them. I need .80 just to break even. I get an offer to buy 500 of my cows, or about 600,000 pounds for .90 per pound next August (futures contract). So I enter into a futures contract for 600,000 pounds of cattle at .90 a pound next August.
If we have a wet spring and a dry summer, corn prices will jump up and more farmers may have to reduce their herd size, flooding the market in August. Cattle prices could drop below .80. I'm protected because I have a buyer that is giving me .90 in August. If this buyer isn't a slaughter house but just an investor, he will have to sell that contract for less than he is paying me, taking a big loss.
But, if during the next few months, Japan and Korea open up to US beef imports, increasing demand, the price next August could reach $1.20 a pound. The holder of my futures contract can sell my futures contract for 500 cows and realize a $180,000 profit.
I still have 500 cows to sell at current market prices and the .90 I got in that contract still earns a profit for me, so all is good.
I don't have to actually own the commodity to sell a futures contract. If I think the price of corn will be way down in October 2009, I can sell an October 2009 contract for 1000 bu. of corn at $4.00 a bu. Between now and then, I watch the price trends. When they are at what I believe is their lowest point, I buy a contract for 1000 bu of corn at, say $3.80 a bu. for October 2009. I make a profit of $200 and haven't shucked one ear.You may ask why would anyone buy corn now for delivery in October 2009, when the price may go down. Businesses need to lock in their supplies far in advance. This process tends to level out the supply and demand, avoiding oversupply and shortages.
The Government bail out is complex. The Government pushed banks into making home mortgages to poor folk in the 1980s. Just remember what political party benifits by helping the poor folk. A home has been the fastest growing asset for most American families. Why not let the poor folk in on it? The Government provided the money, loans at prime. Banks offered very low interest rates to get them started, with the rates to go up in a few years. Poor folk went to Banks and asked about getting a loan to buy a house. Mortgages seldom go into default, so as long as the poor folk could buy food, clothes and a bottle of Royal Crown once in awhile and still cover a mortgage they got their loan. They figured if those money experts thought they could afford it, must be they could.
Then the economy stumbled. People lost their jobs. Pressure on new home construction became a vaccum. People with no reserve (most of America) began to dump their homes onto the Realestate market and then onto the mortgage holders (Banks).
Along the way, Banks sold their mortgages to other Banks. Then those Banks sold a collection of these mortgages to investment furms. These Investment firms took people's savings and bought stocks, Mutual Funds, gold, commercial loans and home mortgages. It is their sole job to spent (invest) the money in ways that will make it grow. It does involve risk and they goofed. Millions of people are losing their retirement savings. Millions of poor folk are losing their homes. I haven't enough fingers to point who is to blame.
Let the Banks fail? This further stalls the economy because they can't make the loans business needs to expand or maintain inventory. People can't buy vehicles if they can't get a loan. Without mortgages home prices will continue to free fall.
Let the Investment Firms fail? Plan on having your folks move in with you, then. Their 401K just blew away.
Let the poor folk lose their homes? We are either going to see a few million more street people or we'll be paying their rent. If we pay their rent, forever, we might as well bail them out now and get them off our backs later.
