how agricultural economics saved futures markets: an ......“the task of a leader is to get his...

College of Agriculture and Life Sciences

How Agricultural Economics Saved Futures Markets: An Untold Saved Futures Markets: An Untold Story of Leadership

Scott H. Irwin

“The task of a leader is to get his people from where they are to where they have not been ”where they are…to where they have not been.

---Henry Kissinger

“Innovation distinguishes between a leader and a follower.”

St J b---Steven Jobs

1. Show how three relatively obscure agricultural economists played a leading role in p y gchanging the perception of futures markets from mere gambling dens to invaluable market institutions

2. Draw parallels to the current d b t b t th l f debate about the role of speculation in commodity markets

College of Agriculture and Life Sciences May 1st

Seller or Buyer or 3.00 “Short”“Long”

College of Agriculture and Life Sciences June 1st

Seller or Buyer or 4.00

“Short”+$2

“Long”-$2

College of Agriculture and Life Sciences June 1st

Buyer or “Long”Long

Seller or 4.00

$2“Short”3.00

Source: Futures Industry Association

The Populist Era: 1885 - 1915

‘‘a den of speculators whose operations [were]

Populist Era Views on Futures Markets*

• ‘‘a den of speculators whose operations [were]... pernicious’’ (Hume, 1888)

• ‘‘an engine of wrong and oppression’’ (Committee g g pp (on Agriculture, 1892)

• capable of introducing ‘‘gradual misery and ruin… ll l ’’(S ith 1893)upon all classes’’(Smith, 1893)

• “wind wheat” and “wind dealing” ‘‘enabled people to sell what they did not possess’’ (Hooker 1901) se at t ey d d ot possess ( oo e 90 )

• moneyed interests ‘‘juggl[ing] quotations’’ and creating and ‘‘tak[ing] advantage of fluctuations’’ (B k 1913)(Buck, 1913)

*as quoted in Jacks (2007)

Source: Santos (2011)

Major 19th and 20th Century Episodes of Attacks on Commodity Futures Markets

Episode DateThe Grange lobbies for a bill defining all futures trading as gambling

1874trading as gamblingWashburn bill introduced into U.S. Congress to levy 10% tax on futures trades

Futures trading banned in Germany 1897Futures trading banned in Germany 1897Trading in options on commodity futures banned in U.S.

Bills introduced into U S Congress banning 1955Bills introduced into U.S. Congress banning onion and potato futures trading

Onion futures trading banned in U.S. 1958

Meet Our Three Heroes

Holbrook Working (1895-1985)

Born in Colorado in 1895

PhD from Wisconsin in 1921

Joined faculty of Food R h I tit t t Research Institute at Stanford in 1925

Retired in 1960 Retired in 1960

“Th W ki “The Working Curve”Curve

F t i t d t b hi hl“Futures prices tend to be highly reliable estimates of what should be expected on the basis of contemporarily available p yinformation concerning present and probable future demand and supply; price changes are mainly appropriate market responses to changes inmarket responses to changes in information on supply and demand prospects.”

F t i t d t b hi hl“Futures prices tend to be highly reliable estimates of what should be expected on the basis of contemporarily available “Random p yinformation concerning present and probable future demand and supply; price changes are mainly appropriate market responses to changes in

Walk”market responses to changes in information on supply and demand prospects.”

Roger W. Gray (1921-1996)

Born in Illinois

PhD from Minnesota in 1953

Joined faculty of Food yResearch Institute at Stanford in 1954

Retired in 1985

The Onion Futures Controversy

“Speculative activity in the futures markets causes such severe and unwarranted fluctuations in the price of cash onions as to require complete prohibition of onion futures trading in order to prohibition of onion futures trading in order to assure the orderly flow of onions in interstate commerce.”

---U.S. Senate Report No. 1631, May 6, 1958

The Onion Futures ActAugust 28 1958August 28, 1958

Thomas A. Hieronymus(1919 2001)(1919-2001)

Born in Illinois Born in Illinois

PhD from Illinois in 1949

Joined faculty of University of Joined faculty of University of Illinois in 1949

Retired in 1981 Retired in 1981

““For many years the anti-futures trading arguments t d d t il th t tended to prevail so that speculation was treated as a necessary evil that accompanied the desirable accompanied the desirable hedging process. During the last decade the balance appears to have shifted so that appears to have shifted so that a favorable view is more widely held. It is doubtful that the favorable view is yet in the ymajority but it is generally held by students of futures markets and increasingly held by members of Congress and the CFTC.” (pp. 298)

““For many years the anti-futures trading arguments t d d t il th t

Annual U.S. Futures Trading Volume, 1955-2010

tended to prevail so that speculation was treated as a necessary evil that accompanied the desirable

accompanied the desirable hedging process. During the last decade the balance appears to have shifted so that 1 5

appears to have shifted so that a favorable view is more widely held. It is doubtful that the favorable view is yet in the

ymajority but it is generally held by students of futures markets and increasingly held by

members of Congress and the CFTC.” (pp. 298)

0.01955 1965 1975 1985 1995 2005

Investment in Commodity Index Funds, 2000-2009

300Reuters Jeffries/CRB Commodity Price

Index, January 2000-February 2009500

2000 2002 2004 2006 2008

S B l100

Source: BarclaysJan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Investment in Commodity Index Funds, 2000-2009

300Reuters Jeffries/CRB Commodity Price

Index, January 2000-February 2009500

2000 2002 2004 2006 2008

S B l100

Source: BarclaysJan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

“Passive speculators are an invasive species that will continue to damage the markets until they are eradicatedcontinue to damage the markets until they are eradicated. The CFTC must address the issue of passive speculation; it will not go away on its own. When passive speculators are li i t d f th k t th t bleliminated from the markets, then most consumable

commodities derivatives markets will no longer be excessively speculative, and their intended functions will be restored.”

Michael W. Masters, Testimony before the Commodity Futures Trading Commission (CFTC) March 25 2010(CFTC), March 25, 2010

“This Report finds that there is significant and persuasive evidence to conclude that these evidence to conclude that these commodity index traders, in the aggregate, were one of the major causes of “unwarranted major causes of unwarranted changes”—here, increases—in the price of wheat futures contracts relative to the price of wheat in the cash market… Accordingly, the Report finds that the activities of commodity index

d i h traders, in the aggregate, constituted “excessive speculation” in the wheat market under the Commodity market under the Commodity Exchange Act.”

CBOT Wheat Futures Prices and Index Trader Net Long Positions, January 2004-September 2009

1400250Index Trader Open Interest (left scale)

Nearby Contract Price (right scale)

Se Ja Ma

Relationship between CBOT Wheat Price Changes and Index Trader Net Long Positions, June 2006-

D b 2009December 2009y = ‐0.000005x ‐0.1123

R² = 0.001115%

rice, W

eek t+1

‐10%

Market P

‐20%

‐15%

% Chang

‐12,000 ‐9,000 ‐6,000 ‐3,000 0 3,000 6,000 9,000 12,000

Change in Net Position, Week t

The Dodd-Frank ActJuly 21 2010July 21, 2010

The A. Bisporigera Prize(aka ‘The Destroying Angel’) ( y g g )

Th k Y !!Thank You!!

how agricultural economics saved futures markets: an ......“the task of a leader is to get his...

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