131131 AND THE BIRTH OF THE CFTC
of Leo Melamed,
before the United States Senate Committee on Agriculture, Nutrition
May 14, 1974.
13113 is just another number identifying one of the interminable
pieces of U.S. House of Representatives legislation. However,
this was no ordinary legislative effort. For U.S. futures markets,
it was a momentous occasion for it represented the end of an
era and the beginning of a new one—this Bill created the Commodity
Futures Trading Commission (CFTC).
within our industry opposed the idea of a federal agency to
regulate futures markets. They cited all of the expected reasons
in opposition: federal regulations will suffocate the markets;
the federal government will create unnecessary red tape; the
growth of federal bureaucracy should be curtailed; federal
bureaucracy will impose burdensome costs on our industry; futures
markets cannot be equated with securities markets; futures
markets expertise can only be found within the markets, etc.
Much of what they said is true.
were, however, compelling reasons for the creation of such
an agency and I, generally speaking, fell into this camp. First
of all, in my opinion it was inevitable. Futures markets were
growing rapidly, expanding their scope and becoming prominent;
it was naive to believe that our markets would be exempt from
federal authority, when all other similar market endeavors
were federally regulated. In other words, it was to be something
akin to a shot-gun wedding. Thus I felt that, if a federal
regulatory agency was unavoidable, it is best that our industry
accept this fate and partake in its creation.
from the foregoing, I was cognizant that a federal agency could
also prove beneficial to the growth of our markets. Our plans
relating to new financial instrument futures were ambitious
and could be greatly assisted with a federal stamp of approval.
Indeed, some innovations—such as a market in Treasury bills,
or a system of cash-settlement—would be impossible to implement
unless the federal government embraced them. Moreover, a federal
agency could aid the image of futures markets and lend us a
measure of credibility.
of the real work—the endless discussions, the education, the
lobbying, and the negotiations—preceded the actual hearings.
This was our last opportunity to prevail in some highly significant
areas that were proposed in a manner contrary to best interest
of futures markets, e.g., economic justification, margin control
and injunctive powers. And it was the final opportunity to
record in the permanent record our views on this new federal
authority as well as a few words of caution.
testimony also had a most interesting sidelight. I reminded
the members of this Senate Committee of the success of American
agriculture compared with nations that were governed by a centrally-planned
economic order and where there were no futures markets. I admonished
the Senators to remember the benefits of futures markets and
that there was no Moscow Commodity Exchange, no Peking Duck
Exchange, and no Havana Cigar Exchange.
words gave Mr. Martin Cohen—the CME's advertising executive
who was in the audience—an idea for a new advertising campaign.
It led to his award-winning advertising theme (and popular
CME posters): "How come there's no Moscow Commodity Exchange?" "How
come there's no Peking Duck Exchange?" "How come there's
no Havana Cigar Exchange?"
I deem it a privilege to come before this Committee, and am honored
to have an opportunity to speak before you in representation
of the Chicago Mercantile Exchange. The position of our Exchange
is not in opposition to the creation of a new federal Commodity
Commission; nor do we oppose many of the provisions that are
under current consideration in the proposed legislation. Indeed,
many of the provisions contained in the House Bill, H.R. 13113
were the result of suggestions that we ourselves initiated.
Nevertheless, we are strongly opposed to several specific provisions
within this legislation and fear that their enactment would be
highly injurious to futures markets operation. For the same
or similar reasons, we also oppose some of the legislative concepts
presently before the Senate. To underscore our point of view,
I would like to explain the areas in which we feel legislation
should be avoided, and convince you that our goal—as yours—is
in the best interests of the public.
there are no commodity exchanges in Moscow; there is no Peking
Duck Exchange in China; there is no Havana Cigar Exchange. The
farmers of those countries have no need for a mechanism that
offers risk transference, price projection, or price protection.
In those countries, the governments establish the prices at which
farmers can sell their products. Consequently, the farmers' primary
risk is entirely removed. Alas, by removing the risk, that system
also removes the incentive. The sorry history of such systems
is that they have been abysmal failures.
contrast, our nation and its agriculture during the last 100
years proved to be the only one in the world that could continue
to produce more food products than we could consume—and of a
higher quality and at a lower cost than anyone else. Mr. Chairman,
there are many reasons for this remarkable fact. But, the central
and primary reason is that we have, for the most part, maintained
a free enterprise system. This is the pivotal difference between
us and them. This is the secret of our success and their failure.
futures markets, Mr. Chairman, are part and parcel of this successful
system as it relates to agriculture. U.S. futures markets have
been in existence for more than 100 years and are integrally
intertwined with our agriculture and agribusiness complex. It
has been proven time and time again that these futures markets
provide some of the most useful and irreplaceable tools for the
producer and the consumer; that the degree of economic benefit
from such markets is, in fact, greater than most would realize;
and that without these tools and services, our agricultural markets
would be severely impaired and far less efficient.
is our very real concern that in any attempt to better the use
of commodity futures markets we not endanger the very function
of such markets. It is our very real concern that, in an attempt
to change them for the better, we not inadvertently affect the
fundamental operation of this complex mechanism. For if the
end result of any new legislation is to impede these contract
markets, we impair the free market system as a whole.
it is most unfortunate that legislation relating to futures was
prompted in large measure by our recent food price spiral. Speculation
at our exchanges was erroneously viewed by some as a possible
cause of the nation's rising prices. This type of reasoning
ignored the fundamental economic and political factors that were
underlying the problem, many of which had been festering for
over a decade. It is a reasoning that is analogous to that practiced
by ancient monarchs who beheaded the messenger of bad tidings.
act as a messenger is, in fact, one of the primary functions
of futures markets. Futures markets, by their very definition,
act to provide us with a glimpse of what is coming. If these
markets had failed to predict the reality of higher prices, they
would not have functioned properly. As a matter of fact, they
did not fail, and moreover, they responded to the emergency far
better than might have been anticipated. Those who blamed these
markets last year for predicting higher food prices, it would
seem, should praise these same markets today for predicting lower
we accept neither the blame nor the praise. In each case, the
markets were acting as a mechanism to transfer risk from the
producer to the speculator. In each case, the markets were acting
much as a giant computer projecting prices into the future. The
markets may not always be correct in their computations, but
they represent a moment-to-moment analysis of all involved in
the marketplace. A barometer such as this cannot be blamed or
given credit for the weather conditions that exist or will occur.
should our markets be castigated because they utilize and are
utilized by speculators. Speculators do not affect the eventual
outcome of actual supply and demand. But speculators are the
essential ingredient that make these markets function. They
are willing to shoulder the risk that the farmer undertakes when
he first plants his crop or buys his heifers—a risk the farmer
wants to shed. It is the risk that Russian, Chinese, and Cuban
farmers do not have. Therefore, they need no mechanism for price
insurance. That is right, no speculators, no exchanges, and no
successful agricultural system.
lies the rub. Should any legislation endanger the liquidity
of these markets, should it create the ability of political or
arbitrary forces to disrupt their operation, should it place
upon markets such requirements that impede their normal processes,
should it stifle innovation,it would be a step toward dismantling
the free enterprise portion of our nation's agriculture and a
giant step toward eventual production quotas. We know where
that road leads.
a matter of fact, our nation has just experienced the horror
of price by administrative edict and its inevitable partner—administrative
supply allocation. It was just yesterday, it seems, that our
Exchange together with other free market institutions and economic
experts pleaded that we not adopt a policy of price controls.
But, we were then but a frail voice in the storm over inflation.
The clamor for immediate relief was too great for Congress and
the President to withstand. So our Government embraced price
controls and, as a result, our nation suffered all of the dire
consequences attendant to that remedy.
we learned any lesson? Are we now ready to accept the proven
fact that, especially in agriculture, there is no solution to
higher prices other than higher production or lower demand?
That higher production cannot be legislated? That lower demand
cannot be ordained? That any material government interference
with profit incentive is counter-productive. That any government
interference with our free enterprise system, which has its own
checks and balances, must inevitably lead to disaster. Have we
learned this lesson, or are we doomed to make this mistake again
legislation that gives a federal administrative agency power
to demand economic justification before a new instrument of trade
will be approved or power with which to unduly interfere with
the function of our futures markets, will be the same step backwards.
It will create the ability to inhibit innovation and influence
price by administrative action rather than the desired influences
of free economic forces. Take, for instance, the issue of margin
control. We are vehemently and unequivocally opposed to any
legislation that would transfer this authority from the exchanges
themselves. Margin is a misnomer with respect to commodities.
There is a fundamental difference, both from a conceptual and
operational standpoint between margin on securities and margin
on commodity futures contracts. Unfortunately, this fact is
sometimes not understood.
market margin is a direct measure of the creation of bank credit.
It determines the proportion between the amount paid for securities
and the amount borrowed for their purchase. There is no such
relation in futures markets. In futures markets, margin acts
as a surety or security deposit. It is conceptually designed
to protect the financial solvency and integrity of the brokerage
firm. Our record in this regard is remarkably good, particularly
in comparison to the record of securities brokerage firms even
though those exchanges have been supervised by the SEC since
the other hand, the function of margin in commodity markets is
geared toward protecting the monetary variance between daily
fluctuations. The margin required is not measured by the value
of the product or contract, but is determined by the volatility
of the market and the possible change in daily price movement.
It is earnest money to guarantee the sanctity of our contracts.
who has carefully studied futures markets should reach the same
conclusion as did the Nathan Report of December 1967.
This report was the result of a study on this subject made at
the behest of the USDA. It concluded that margin on commodity
futures markets cannot be utilized for any purpose other than
the one presently used without impairing the actual operation
of the market itself. That its function is to act as a security
deposit and cannot relate to payment on credit towards purchase
of the product. And, furthermore, that no agency is better equipped
or situated to regulate this area than the exchanges themselves.
this power transferred to another agency or utilized for any
other purpose, one could easily see how such power could be applied
to create artificial causes for price movement. Mr. Chairman,
we would again be on the threshold of price control.
legislation that delegates uninhibited injunctive power over
these markets to an agency or commission creates the possibility
of affecting price by the threat of administrative action. Any
such legislation must clearly delineate, without ambiguity, the
conditions, causes and purposes for which such injunctive power
is to be utilized. Otherwise, such legislation will prove to
be a much greater detriment to our markets than are the ills
they attempt to correct.
it is our fundamental belief that the best and most successful
manner of regulation is self-regulation. We submit that any
legislation that fails to take this principle into account will
fail in its primary objectives. We believe that the exchanges
not only have the necessary and intimate knowledge of the market
operation but also have ready access to the personnel and expertise
vital for correct administrative action in matters relating to
the intricacies of these markets. It would indeed be a disservice
to our nation if the new legislation failed to tap and properly
utilize these resources.
urge that the new legislation, particularly in sensitive areas
affecting price, liquidity and margin provide a means for the
contract markets to first do it right, and for the new agency
to intercede only when and if the exchanges have neglected this
by permission. Excerpted from Melamed on the Markets, by Leo
Melamed. John Wiley & Sons, 1993
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