TheEconomist wrote:Can you trade something that doesn't exist?
Like these rings: CL/$, WTI/$, CL/WTI ; or CL/$, KE/$, CL/KE
Those crosses (oil among themselves, oil to wheat...do they exist)? If no, how do you close the ring?
you can trade value1/value2 pairs if there exist interconnected direct quotes between these two values.
For instance, if you want to trade 1 barrel of oil / 1 ounce of gold and no one is quoting this value pair directly, you can look around and find out that there exists 1 barrel of oil / 1 USD quote as well as 1 ounce of gold / 1 USD quote.
Then, if you want to be long oil / gold, you simply go long oil/USD and short gold/USD having the position size constant based on the number of USD units.
Having said the above, you can close the above incomplete FPI ring that includes oil, gold and USD, by tapping into another commodity market. For instance, you can do this by opening positions in oil/EUR and gold/EUR having the position sizes constant based on the number of commodity units.
You can see that if there were no currencies available, you would not be able to trade oil against the gold as there would be no medium of exchange between these two commodities. And that's also the beauty of currencies: most people think money is a commodity by itself. But money is only worthwile if you can use it as a medium of exchange. And also, it's only worthwile if enough people believe they can use a particular medium of exchange to exchange their commodities and services.
Remember that Charles II of England was using wooden sticks as a medium of exchange. As enough people believed this is the currency, it worked as a currency.
Now do you think a paper rectangle with something printed on it (a dollar bill, for instance) possesses a higher value by itself than a wooden stick?