FUTURES MARKET IN CURRENCY
to the New York Society of Security Analysts, Inc.,
New York, New York,
April 19, 1972.
criss-crossed the United States dozens of times during the
months leading to the birth of the IMM and hundreds of times
more during the years thereafter in an unending attempt to
explain our new concept and the rationale behind it. I was
like an evangelist spreading the gospel of a new religion,
obsessed with the concept, its promise, and its potential.
I accepted every opportunity to be heard.
say I was cognizant of the revolution and potential this new
market represented was a bit of an understatement. In what
amounted to nothing short of audacious bravado I stated in
the first Annual Report to the IMM members that: "The opening
of the International Monetary Market on May 16, 1972 was as
revolutionary a step as the establishment of the first organized
commodity exchange when that event occurred." "...We believe," I
concluded, "that the IMM is larger in scope than currency futures
alone, and accordingly, we hope to bring to our threshold many
other contracts and commodities that relate directly to monetary
matters and that would complement the economics of money futures."
the time of this address, we were less than thirty days from
what was to become the dawn of the financial futures revolution.
Most of the financial world had ignored the coming event. Others
scorned our idea, ridiculing the idea that financial instruments
could become the realm of futures trade. The chance to appear
before the New York Society of Security Analysts was a welcomed
opportunity to preach to the heathens.
the eve of the birth of the International Monetary Market, it
is fitting to address the Society of Security Analysts. My mission
is to explain why there should be a futures market in currency,
how this market will be different from the existing interbank
forward system used by the commercial world, and why we believe
the IMM will succeed.
why is there a need for a futures market in currencies? In other
words, might this not merely be the invention of a legalized
form of gambling, another unnecessary evil? Certainly that has
been suggested by many, on more than one occasion. One might
even ask why a futures market in anything?
fact of the matter is that, whether we like it or not, we deal
in futures all the time. The housewife who buys more than she
immediately needs because a given product is on sale; the butcher
who contracts for delivery of pork at an agreed price months
in advance of his anticipated sales: the weaver who agrees to
deliver his cloth at a future date, long before the product is
ready; the wholesaler who builds inventory in advance of anticipated
the investor in real estate speculating in futures? Isn't the
farmer doing the same when he plants his crop? Surely a securities
analyst is speculating in futures when he gives a buy recommendation
on a particular stock on the basis of his projection of future
earnings. Doesn't the buyer for a department store take into
consideration the same elements that go into a futures market
trade? What is the supply, what is the demand, what is the trend?
Indeed, there are thousands of everyday examples in business
and social life that inherently include the elements of futures
trade and futures speculation. Dealing in futures is an ordinary,
this suggest that we are always gambling? I suppose so, in a
sense. But only in the sense that we gamble when we cross a busy
intersection. Rather, I think what we are doing is applying to
our social and business needs those factors that experience has
taught us are necessary and prudent in moving successfully through
life. We walk on the green light and look both ways before we
cross the street. A futures exchange is an extension of this
principle. It is a central facility for businessmen who wish
to cross the street —more safely. It is a mechanism which provides
the procedure and prescribes the rules by which certain spheres
of commercial activity can shed some risk and implement their
business needs in a more prudent and organized fashion.
the first question posed is approached from this perspective,
the question is not why, but rather why not a
futures market in currency? And why did it take so long to come
begin with, an organized exchange cannot establish a market in
a given product unless society has an inherent need to transfer
risk. In other words, to be viably traded on a futures exchange,
the commodity in question must be subject to consistent and substantial
price changes which necessitate forward transactions. This also
implies that the commodity to be traded at a futures exchange
must be one that already sustains an active, albeit, decentralized
meets the foregoing requirements. Even before the decision
on December 18, 1971 by the financial ministers of the Group
of 10 foreign—to substantially widen the permissible band of
exchange-rate differentials between the dollar and other currencies
from existing parity to plus or minus 2.25 percent—currency was
actively traded in the interbank market on a spot and forward
basis. The decision by the Group of 10, necessitated by the dictates
of reality, officially recognized that currency price fluctuations
were going to continue in a consistent and substantial manner.
The new rate of parity—and the strong probability of further
band expansion or even currency floating, whether by traditional
floating methods, crawling pegs or other forms of parity adjustments—dramatically
increased the need for importers, exporters, multinational corporations
and financial institutions to learn and utilize the currency
interbank market for their international business transactions.
One can hardly open the newspaper these days without coming across
an item about a loss suffered by a major company as a consequence
of currency value changes, or about a corporate comptroller who
was relieved of his duties because he neglected to protect his
employer from the possibility of currency devaluation or revaluation.
Clearly, the basic elements for currency to be listed for trade
on a future exchange are abundantly evident.
real question is should a futures exchange undertake to do so?
For the answer, allow me to quote from Professor Milton Friedman's
paper, The Need for Futures Markets in Currencies, commissioned
by the Chicago Mercantile Exchange in the fall of 1971:
in the international financial structure will create a great
expansion in the demand for foreign cover. It is highly desirable
that this demand be met by as broad, as deep, as resilient
a futures market in foreign currencies as possible in order
to facilitate foreign trade and investment.
leads us to the second question: How is the futures market different
from the existing interbank market? If one simply examines a
general definition, the interbank market performs the same functions
as our intended futures market. Both markets will provide the
mechanism for the purchase and sale of currency for delivery
on a forward date. Both, then, allow for the transfer of risk.
However, the similarity ends with the general definition. The
differences begin in application.
most basic difference is that the interbank market is restricted
to the commercial world. A futures market will not succeed unless
it draws participation from both the commercial user as well
as the speculator. And, why not the speculator? Doesn't the
individual—be he speculator or not— have a similar right as does
the businessman to protect his estate from possible loss by virtue
of currency change? Would it be fair if the individual—speculator
or not—were excluded from the stock market, the bond market,
or the real estate market? But, more importantly, could these
markets work effectively without the individual speculator? The
speculator's role in a futures market is imperative. It is the
speculator who can provide constant bids and offers in the market.
It is the speculator who is willing to accept and offset the
risk of the commercial user. It is the speculator who can fuel
the necessary liquidity without which the commercial participant
cannot effectively use the market. Friedman's requirement for
breadth, depth and resiliency are precisely the features that
can be best provided by an organized futures exchange. Or to
put it another way, it is our view that a market in currency
will become viable only through the interaction of speculative
and commercial activity in an open, free and competitive arena.
Such an arena is what we provide.
second paramount distinction between the interbank and futures
market is the nature of the transactions. Futures markets are
impersonal. They are not tooled for the specific needs of each
separate business transaction, nor is each transaction defined
by the buyer's or seller's specific need of that moment. Instead,
every transaction is based on the same uniform unit of trade,
the same uniform manner of delivery, on the same uniform predetermined
forward date. The element of uniformity is unique to organized
futures exchanges and is perhaps the quintessential ingredient
of their existence. This ingredient makes it possible for every
participant to offset an existing market position with any other
participant regardless with whom the original transaction was
undertaken. Consequently, the exchange becomes the clearinghouse
of all the transactions which allows the exchange to act as the
guarantor to the buyer as well as to the seller. No similar capability
exists in the interbank market. It is the underpinning of liquidity
difference is in the way transactions are made. In the interbank
market transactions are private, making it necessary to get other
quotes to ensure the price you are quoted is fair and competitive.
In the futures market, bids and offers are by open outcry in
an open and competitive arena.
dramatic but also important is a futures exchange's capacity
for compiling and disseminating facts, statistics and information
concerning a particular market. There is no other agency, except
perhaps the federal government, that can better serve the public
and industry concerned. And there is today an overwhelming need
for information on the subject of currency. This demand is going
to continue and increase. A futures exchange is capable of fulfilling
this need in an organized and comprehensive manner.
exchanges can also provide the necessary service and communication
mechanisms to make their markets accessible to every segment
of commerce, industry and the public in every corner of the globe.
An exchange can and will provide instant access to all participants,
enabling them to translate their needs to action in seconds.
Consequently, interest in the currency market will expand substantially.
When it does, the need for informed advisors will grow and an
educational process within the brokerage industry will ensue.
While this process is slow and often intangible, it nevertheless
is very real and desperately needed. When it happens, it will
greatly benefit the interbank market as well.
a futures exchange will act as a public weather vane and instant
barometer of the market. It will offer an up-to-the-minute opinion
poll of skilled, unskilled, public and commercial experts concerning
the value, stability or lack of stability of a given currency.
Good news or bad will openly and immediately be reflected in
the price of the product. This is a vital element of a competitive
marketplace and integral to the free enterprise system.
foregoing are but a few of the basic differences between the
futures and interbank markets. There are many more, but none
of them are such that they prevent co-existence. As a matter
of fact, we are certain that if the IMM is successful, it will
both complement and supplement the existing spot and forward
currency market. The interbank market will learn to depend on
the futures market and vice versa.
we be successful? The best and honest answer is that only time
will tell. We have the will and the fortitude; we have the facilities,
the infrastructure, the personnel, the breadth of membership,
the communications mechanisms and (we think) the correct contract
specifications. Moreover, while there are many who disagree,
in our opinion all indications so far are that we will triumph
with this idea. The interest we have generated from commerce
and public alike—even before we started trading—has been phenomenal.
Even the banking community—which received the idea coolly at
first—is taking a second look and in many cases has lent a hand.
Several respected bank officials have even joined our Board of
Directors. In addition, we have received help, advice and encouragement
from virtually every segment of the academic and financial world
as well as from the federal government. And this is only the
realize we have much yet to learn and that much of our knowledge
will come after the market has opened. As we learn, our market
may change; in fact, it may be dramatically different from what
it will be on opening day. Nor do we anticipate instant success.
We strongly feel that because the concept is important and correct,
our market must be given a minimum test of two or three years
before it can be judged.
why us and why here? Again Milton Friedman answered the query:
a wider market is almost certain to develop in response to
the demand. The major question is where. The U.S. is a natural
place and it is very much in the interest of the U.S. that
it should develop here. Its development here will encourage
the growth of other financial activities in this country, providing
both additional income from export of services and easing the
problem of executing monetary policy.
the Chicago Mercantile Exchange is a large and established futures
institution with the expertise to take on such a mission; us—because
the Chicago Mercantile Exchange has created a unique and separate
futures entity to exclusively trade in financial instruments.
We believe in the future of the International Monetary Market.
We are ready to do everything that is necessary and to give it
the full measure of our ability toward its success.
by permission. Excerpted from Melamed on the Markets, by Leo
Melamed. John Wiley & Sons, 1993
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