Reprinted with permission from the Fall 1999
issue of Global Custodian Magazine http://www.globalcustodian.com.
An Asset International Publication
From the beginning of recorded history, there has
been one form or another of forward or futures markets where merchants
and farmers could hedge their inventories, but it was not until
1952—the same year that Harry Markowitz published his remarkable
paper on quantitatively measuring financial risk—that contracts
to hedge money, the ultimate commodity, finally appeared.
Invented by Leo Melamed, a young Polish-Jewish immigrant
who arrived in Chicago during World War II, financial futures were,
like many great inventions, a child of necessity.
Educated as a lawyer, Melamed turned to commodities
trading as a way to supplement a young attorney's meager income
and help support his family. Gradually, he learned to survive,
and eventually prosper, as a commodities trader on the Chicago
Mercantile Exchange (CME). An ambitious trader who was well respected
by his peers, he rose through the ranks to become the CME's chairman
in 1898 as a butter and egg exchange, the CME migrated to meats
when the butter and egg market collapsed in the mid-1960s. But
the CME, for all intents and purposes, was a single-industry
exchange. "If meats were to collapse, the CME
would be out of business," Melamed recalls.
Melamed notes his invention came about for several
reasons. The first was the coming demise of the 1944 Bretton Woods
agreement, which fixed the values of major currencies to each other.
The second was a personal interest in currencies called out of
his flight from the Nazis as a child, taking him from Poland to
Lithuania to Russia to Japan to New York, and finally, to Chicago.
The last, and likely most significant reason, was his perception
that the CME he was now in charge of needed diversified products
The idea for currencies contracts was classically
simple. If one could hedge meats, metals, coffee, sugar, cocoa,
and grains, why not money?
Never an economist, Melamed argued with himself that
if financial futures (which they were later to be called) were
such a good idea, why hadn't anybody thought of it?
Eventually, Melamed described his idea to the prominent
economist Milton Friedman, who was enchanted with the idea. In
1971, he commissioned Friedman to write a feasibility paper so
his invention would gain credibility. In August that same year,
President Nixon unpegged the dollar against gold and the Bretton
Woods world of fixed currencies was no more. In 1972, the first
currencies futures contracts began trading on the CME.
Financial futures did more than just permit people
to hedge money. They also allowed Markowitz's modern portfolio
theory to develop because price discovery of macro instruments
like the currencies and later T-bills, T-bonds, and stock indices,
was publicly available in a continuous, second by second, series
of pricing events.
Previous to futures, these instruments were traded
in over-the-counter markets amongst big dealers where bids and
offers were usually not public knowledge. Indeed, no one could
measure the exact value of financial instruments, except for stocks.
The commodities exchange practice of open-outcry
changed all of this. Now, exact values of major financial instruments
were instantly available at any point in time. This, as much as
finally realizing they could hedge their inventories, is what persuaded
financial institutions to accept Melamed's invention and all the
various hybrids that were soon to follow on many other exchanges.
Milton Friedman has sometimes been credited with
being the co-inventor of financial futures, but in a foreward to
one of Melamed's books, Friedman says clearly that the idea was
While Melamed, not being an economist, was never
honored with a Nobel Prize for his remarkable invention, the enormity
of the economic and social benefits his creation has bestowed on
the world in the last two decades argues that he should have been.
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