Back when I was a futures trader working at a Canadian bank, I’d often wonder why the future prices of certain commodities would be higher than spot prices, then at other times, those future prices would be lower than spot prices. I’d read somewhere that Keynes had written something about contango and backwardation, the terms used to describe when future prices are either higher or lower than current prices. So I decided to take the library and find out what Keynes actually wrote on the topic. It turns out, he didn’t say much, at least nothing useful in my opinion, but he’s quoted widely on the topic and even today, the wiki article is titled “normal backwardation” the term Keynes used to describe it.
There is nothing “normal” about either contango or backwardation. We can tell empirically from historical data that some things tend to be more often in one state or the other. the S&P 500 futures contract are almost always in contango, but the future price for oil is sometimes in contango and other times its in backwardation. So what gives? why? We still don’t know, but everyone has an opinion.
Keynes wrote in his Treatise on Money that backwardation is normal, and it comes from the idea that producers of commodities are more prone to hedge their price risk than consumers. Not sure these thoughts would hold up in the academic world of today (or maybe they would?), but nothing is “normal” in a free market, things only are based on your own perception of what is real. There are reasons why markets would be contango or backward, carrying costs, expectations of future value, etc.
Now that we’ve discovered blockchains and crypto currencies, we have more information to analyse and debate. Bitcoin has very little carrying costs, can be easily traded with very frictional costs, etc, and yet, the forward price for bitcoin currently trades in contango. The spot price on Deribit is 18500, the 1 month future is 18863, and the 3 month future is 20846. On the CME, the spot price is 18591, the 1 month future is 19105, 3 month is 19340, and the 6 month future is 19300.
We also know how much the rate is to borrow and lend bitcoins. We can see on Bitfinex and Poloniex that the interest rate on bitcoins is very low, close to zero.
How does the market’s expectation of future value impact the rate of interest bought and sold today? If I’m expecting something to become much more valuable in the future, then I’m willing to accept a lower rate of interest to lend it, and if I expect something to become less valuable in the future, then I’d demand a higher rate of interest. This can observed by comparing the rate of interest to lend/borrow US dollars on Bitfinex compared to the rate for bitcoins. The interest rate on US dollars, which maybe the market expects will become less valuable in the future commands a much higher rate than bitcoins, which the market might expect to become more valuable. Yet both rates are positive.
We are used to being compensated by a positive interest rate to lend our fiat money until a future date, and we are used to paying a price to borrow money today in order to pay it back at a later date. Could this be due to the productive capacity of capital? We live in a world where we can create more tomorrow with the capital we can marshall today. But we could just as easily demand the opposite. If the future liability of money is greater than its current value, then I’d like pay someone to take my money now, and get less of it back in the future. I’d accept a negative rate of interest in order to reduce my future liability. This state of economy is happening in some places today like Scandinavia, Japan, Switzerland, etc. In these places, capital is being used to consume today, and it’s not being invested productively, so interest rates become negative. Governments try and use Keynesian economics by increasing the money supply, trying to make the prices of things rise (since money is on the denominator), but the impact of increases in the money supply is also the expectation that it becomes less valuable in the future, so investors are willing to accept negative rates of interest because they know they will get more of it by way of the government (who is also who prints the money) in the future.