TOMORROW'S FINANCIAL MARKETS

Submitted to The Forward
New York, NY
March 17, 2000

Any attempt to predict the future is fraught with danger, and anyone attempting to write about tomorrow's financial markets must do so with all humility and with the express understanding that what they predict may be totally off base.

Yet a look at events during the latter half of the 20th century may offer clues. During that period, transistors and their offspring, the microchip, transformed everything: the computer, the space program, the television, the automobile, telecommunications and, to be sure, the markets. We migrated, said Walter Wriston of Citicorp, to the "information standard." Modern telecommunications capabilities fostered instant mass informational flows in total disregard of internal prohibitions or national boundaries. This proved to be the common denominator for the dramatic political upheavals we witnessed in the last decades of that century.

By connecting the world with instant information, the transistor caused the earth to shrink. We call it globalization. Today, as a result, for the first time in human history, nearly every country on the planet has a market-oriented economic system and is attempting to become a competitor in the global marketplace. For the past 20 years when we spoke of a global economy, we were talking about only 25% of mankind–mostly North America, Western Europe and Japan. And as recently as 1989, almost 70% of mankind was living under Marxist or socialist economic systems. Today, there are 3 billion more participants in the capitalist system and every aspiring center of finance the world over wants what America has.

What America has, political and economic freedom, lies at the very core of the success of American markets. But globalization also demanded the invention of broad based instruments of finance that would enable market participants to measure constant changes in values and provide the means to hedge the resulting exposures. The era of financial derivatives was born in response, primarily on the floors of American futures exchanges—the veritable hub of innovation throughout the 1970s and 1980s. This era acted as the primordial soup upon which financial engineers used computer technology to unbundle existing financial risks into their basic components. It enabled risk to be allocated to those investors most able and willing to take it. In doing so, these financial instruments increased liquidity in capital markets and helped develop a more efficient global intermediation process. As a result, financial derivatives have played a major role in fueling the economic engine that brought America and the world to the current state of unprecedented prosperity. In the words of the chairman of the Federal Reserve, Alan Greenspan, By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives....a process that has undoubtedly improved national productivity, growth and standards of living.

It is not anticipated that the role of financial derivatives in tomorrow’s financial markets will diminish. These instruments are used to protect against interest rate and exchange rate exposure, to manage assets and liabilities, to enhance equity and fixed income portfolio performance, to protect against commodity price rises or mortgage interest expense.

As a consequence of their application, risks are reduced and profit is increased over a wide sphere of financial enterprise and in various ways___from businesses whose efficiency is enhanced to banks whose depositors and borrowers are benefitted; from investment managers who increase their performance for clients to farmers who protect their crops; from commercial users of energy to retail users of mortgages. But while the application of these financial instruments will remain, the means by which they are applied will change dramatically.

Indeed, in stark contrast to the signals at the at the beginning of the 20th century, the evidence today is overwhelming that the next century will be dominated by the information standard. Today, millions of transistors are etched on wafers of silicon. On these microchips, all the world’s information can be stored in digital form and transmitted to every corner of the globe via the Internet.

It is no leap in logic to assume, as many have, that information technology will be to the 21st century what electricity was to the 20th century. The Digital Age will change, and is changing, the way we live, work, play—and the way the markets work. The markets of the future will be automated. The traders of the future will trade by way of the screen. Those who dare ignore this reality face extinction.

Today's cyber-wizards have combined the magic of all electricity and physics to produce a sorcery that can carry a computer command, the human voice or virtually any program including market information, quotations, analysis, and market orders from anywhere to anywhere at a speed of about three-quarters of the way to the moon with every second.

By unplugging ourselves from existing infrastructures, networks of information, and communication hookups, we will suddenly have many more choices about where we live and work, and how we trade. Telephones as we knew them will soon be history. Everyone will be connected, carrying small pocket devices that will not only be used to communicate but to download money or to trade. The new technology will have merged the computer, communications and the Internet into a small wireless marvel. Wireless e-mail will be the dominant personal telecommunications instrument and the trading mechanism of choice. Tiny chips might even be implanted in our bodies that could act as a universal credit card, passport, driver’s license or even to transmit buy and sell orders. Surely, national and economic borders that have already been blurred, may dissolve completely, as communication satellites enable consumers and traders to do transactions in cyberspace. And now that we have seen the birth of the Euro, representing a single currency for much of the European zone, and there is serious talk of a similar dollar zone for the Americas, perhaps in the 21st century a one world currency will evolve___digital money.

To be sure, the Cyberspace Age will cause an enormous shift of power from the producer to the user. Technology is a force for democracy and individual empowerment. The consumer will become king because the Internet changes the old rules. Consumers who don’t like what they see will just click and move on to the next screen. Those corporations who are merging and are betting that bigger is better may be looking in the rear view mirror; with the cost of entry lower and easy access to the global marketplace via the Internet, competition may come from smaller entities with a flexibility to offer innovative services. In the past, success in business had three rules: location, location, and location. In the future, where you are located may not matter.

While all of this is exciting and promising, we must conclude by injecting a note of caution. The only certainty about the future is to expect the unexpected—which by definition is unpredictable. The road for markets that I have suggested may not happen at all, and if it does, it certainly will not be in a straight line fashion. There are bound to be diversions, detours and disasters along the way. Euphoria about present market conditions may abruptly and unexpectedly turn into disillusionment. But those of us in the markets are commissioned not to shrink from the unforseen, nor to fear failure. We are commanded by our profession to seek new market solutions and respond to difficulties as they arise. Above all, we must not become victim to what Rose and Milton Friedman call "the tyranny of the status quo." New ideas and innovations must remain our credo.

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