INTERNATIONAL MONETARY MARKET OF
THE CHICAGO MERCANTILE EXCHANGE
in The Merits of Flexible Exchange Rates: An Anthology
things are more symbolic of flexible exchange rates than the
International Monetary Market (IMM) in Chicago. Indeed, the birth
of this futures exchange on May 16, 1972 is inextricably intertwined
with the death of Bretton Woods, occurring as it did but a few
months after President Nixon officially closed the gold window
and ended the system of fixed exchange rates.
the IMM represented much more than a new economic era or the
successful introduction of currency futures. In May of 1986,
precisely fourteen years after its inception, Merton H. Miller,
Distinguished Service Professor of Finance at the University
of Chicago Graduate School of Business, bestowed upon the IMM
a supreme and unparalleled honor—he nominated financial futures
as "the most significant financial innovation of the last twenty
is not my place to admit or deny this distinction. Professor
Miller and others of his distinguished credentials are eminently
more qualified than I to make such determinations. Rather, I
am best placed to reflect on the events surrounding the birth
of our currency markets, to recall some of the noteworthy moments
of the IMM's formative years and to answer questions about who
we were, and whether we knew what we were doing.
dare say, if ever one needed proof of the sagacity of "necessity
is the mother of invention,"(2) one
need only review the economic disorders leading to and following
the creation of our new exchange. These events proved beyond
anything we could say that the IMM was an invention made necessary
by the dictates of the times.
date most observers would mark as the official onset of financial
upheaval would be August 15, 1971. That day, President Nixon
announced his economic emergency package which included a wage
and price freeze, a 10% import surcharge, and the suspension
of dollar convertibility into gold and other reserve assets.
Unquestionably, the closing of the gold window was a seismic
shock that unleashed financial reverberations that were felt
even a decade later.
is unfair, however, to characterize any one event as critical
to the actual beginning.(3) No
one factor is responsible for the chain of events that culminated
in the financial tumult of the 1970s and early 1980s, except,
of course, the 1945 Bretton Woods Agreement itself.
my humble opinion, Bretton Woods was a short-term solution uniquely
suited for post-World War II reconstruction. If applied much
beyond that, as it was, then its basic and fundamental flaw—its
rigidity—was destined to become its undoing. A fixed exchange
rate system could not forever effectively cope with the continual
change in currency value resulting from the daily flows of political
and economic stresses between the member nations of Bretton Woods.
different external and internal interests of the participants—their
different rates of economic growth; their different fiscal and
monetary policies, beholden to different forms of governments;
their different work force considerations; their different election
timetables and political pressures—all would combine to destroy
a system dependent upon a unified opinion regarding respective
Friedman knew this from the beginning:
from the time Bretton Woods became effective, it was inevitable
it would break down... It tried to achieve incompatible objectives:
freedom of countries to pursue an independent internal monetary
policy; fixed exchange rates; and relatively free international
movement of goods and capital...As one of the architects of
Bretton Woods, Keynes tried to resolve the incompatibility
by providing for flexibility of exchange rates through what
he intended to be frequent and fairly easily achieved changes
in official parities. In practice, this hope was doomed because
maintaining the announced parity became a matter of prestige
and political controversy. Countries therefore held on to a
parity as long as they could, in the process letting minor
problems grow into major crises and then making large changes...(4)
December 1971, when the IMM was officially incorporated as an
independent financial exchange, it was obvious to some of us
that the imbalances created and pent up by fixed exchange rates
were about to erupt. President Nixon's economic measures were
only one of those effects and were immediately followed by a
number of joint international actions and pious pronouncements
which, for the most part, turned out to be futile. These were
followed by a series of amendments and counter-measures that
proved equally useless and simply added to the general confusion.
currency realignments as well as dollar devaluation. These attempts
at a new foreign exchange value standard were doomed from the
outset since they were not much more than a reshaping of Bretton
Woods in a slightly more flexible form.
Basle Agreement for the European Economic Community (EEC) established
the so-called "snake" (6) for
EEC currencies. This regime was novel in that it allowed EEC
currencies to jointly float against the dollar while the movement
between each currency was restricted to a predetermined band.
The concept has, of course, survived to this day.
there were an unending series of currency revaluations and devaluations,
entering and leaving the snake, IMF agreements, amendments and
inevitable disagreements—all proving that the world was in serious
centerpiece of the unfolding disarray occurred in 1973. In October
of that year, the oil embargo, oil price increases and the Arab-Israeli
war set in motion economic distortions that would dramatically
change the world financial fabric for a long time to come.
followed was an era of financial turmoil rarely equaled in modern
history; turmoil that tested the very foundations of western
society: the U.S. dollar plunged precipitously; U.S. unemployment
reached in excess of 10%; oil prices skyrocketed to $39 a barrel;
the Dow Jones Industrial Average fell to 570; gold reached $800
an ounce; U.S. inflation climbed to an unprecedented peacetime
rate of 20%; interest rates went even higher.
events ensured that the formula for successful invention based
on necessity would be applicable to the IMM. Indeed, if one could
ordain the perfect backdrop for the creation of a new financial
futures exchange designed to help manage the risk of currency
and interest rate price movement, one could not have bettered
what actually happened.
it seems our exchange had embraced the single most effective
remedy for the dramatic shocks of the next decade and a half.
Here is the International Monetary Fund's assessment of floating
exchange rates as published in its Occasional Paper, July, 1984:
the events of the past decade, it is easy to be impressed by
the resiliency of the present system...Indeed, in such an environment,
managed floating might well have been the only system that could
have functioned continuously.
an even stronger statement was issued by the Group of Ten, as
published June 21, 1985, "...it is questionable whether any less
flexible system would have survived the strains of the past decade..."
we claim that we anticipated the exact nature of the turbulence
that followed the IMM's creation? Of course not. It was simply
that, as traders with an ear to the ground, we had heard the
inner rumblings and knew there was trouble ahead. Did we grasp
the vast potential of the idea? I believe so. This was the precise
query pressed upon me by Milton Friedman when he served as guest
of honor at the occasion of the IMM's tenth anniversary. Did
we, he asked, actually envision the scope of our invention at
the time of its launch?
answer was easy to locate. It is to be found in the Annual Reports
to the members of the Chicago Mercantile Exchange (CME), the
entity that spawned the IMM.
1972 Annual Report, the first to speak officially of its offspring,
was not at all bashful in its assessment of what it had wrought:
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 ...
believe 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.(7)
year later, the first International Monetary Market Annual Report
also focused on the era ushered in by the new exchange:
new era will afford us the opportunity to expand our potential
into other areas within the monetary frame of reference. That
was the essence of the philosophy that fostered the IMM. Our
new market was specifically designed to encompass as many viable
trading vehicles in the world of finance as practicable. We must
be willing and ready to explore all possibilities.(8)
while our grammatical prowess may have been less than perfect,
our eyesight was 20/20. We were fully aware of the revolutionary
nature of financial futures and equally cognizant of their vast
potential. Nor did we delude ourselves about the difficulties
that lay ahead.
ludicrous to think that foreign exchange can be entrusted to
a bunch of pork belly crapshooters," proclaimed a prominent
New York banker on the eve of the Merc's launch of the IMM.
New Currency Market: Strictly for Crapshooters," echoed Business
Week, condemning us from the start and preaching that "if
you fancy yourself an international money speculator but lack
the resources...your day has come."(9)
what you would describe as a friendly endorsement. Indeed, the
world not only misread our purpose, but our potential as well.
In retrospect, the antagonism stemmed from three factors: misunderstanding
the depth and power of financial forces pent up by twenty-five
years of fixed exchange rates, misreading the nature and value
of the idea we had spawned, and miscalculating who we were.
course, there were some notable exceptions. For one, Milton Friedman,
who not only provided us with the intellectual courage to proceed
undaunted by the sea of skepticism about us, but also lent our
concept his esteemed academic credentials; without this help
we could not possibly have defended ourselves from the onslaught
of official and unofficial negativism awaiting us.
Professor Friedman in the position paper commissioned by the
CME 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.
a wider market is almost certain to develop in response to
the demand. The major open question is where. The U.S. is a
natural place and it is very much in the interests of the U.S.
that it should develop here.(10)
words and scores of subsequent supporting actions by Friedman
on behalf of the IMM were invaluable in facilitating our birth,
and indispensable in supporting our fragile existence during
our formative years.
begin with, although CME counsel assured us that we did not need
governmental sanction to proceed,(11) we
thought it prudent to acquaint the appropriate U.S. officials
with our intentions. We felt, correctly as it turned out, that
there were compelling reasons to touch base with our government
(and later with other governments): first, to give the IMM concept
the proper level of import and prominence; second, to gain, if
possible, a positive reaction that we might be able to use in
promoting the idea; and third, if the opposite were true, to
control any negative fallout.
first government official to receive the Friedman paper formally
was George P. Shultz, who became U.S. Secretary of Treasury shortly
after the launch of our market. Mr. Shultz offered immediate
and warm support. While he gave the project long odds, he recognized
its inherent values and embraced Friedman's philosophical rationale.
No doubt his own free market views were in sync with those of
his fellow Chicagoan.
similar fashion, we paid courtesy calls on Dr. Arthur Burns,
Federal Reserve Board Chairman, and Herbert Stein, Chairman of
the Council of Economic Advisors. In each instance, Friedman's
paper had paved the way for a receptive encounter.
sooner did currency futures show signs of success, than we began
to consider the next logical step in the financial revolution—a
futures contract on interest rates. Toward this goal we were
greatly assisted by the current Chairman of the Council of Economic
Advisors, Dr. Beryl W. Sprinkel, who as Vice President and Economist
of Harris Bank and Trust Co., served on the IMM's original Board
recall vividly how, in 1975, Dr. Sprinkel accompanied us to Chairman
Burns to discuss our prospective Treasury bill contract. It was
a momentous occasion in our history; by extending financial futures
to interest rates, we would dramatically expand our horizons.
Moreover, this second meeting with Dr. Burns was no longer a
mere courtesy call. By then, as previously noted, new futures
contracts required CFTC approval. Chairman Burns loved the idea.
course, Treasury futures faced one more hurdle, the United States
Treasury. Its consent did not occur until Milton Friedman wrote
a letter explicitly recommending the new contract to William
E. Simon, U.S. Secretary of the Treasury in 1975. Mr. Simon readily
another early and avid supporter of our proposed T-bill market
was the recently appointed Federal Reserve Board Chairman, Alan
Greenspan, who in 1975 was Chairman of the Council of Economic
Advisors. Dr. Greenspan unequivocally embraced the concept. Indeed,
I recall his immediate reaction as he offered a litany of uses
such a futures market could provide the business community. His
list included all the reasons why T-bill futures were an instant
recall also Herbert Stein's cryptic comment upon learning of
this new futures contract. Quipped the former CEA Chairman, "I
oppose little between two consenting adults."
positive reactions from government officials were important,
the contributions by members of the business community who served
on the early IMM boards were equally meaningful. Not only did
each of these gentlemen give us advice and assistance, they provided
our fledgling exchange with the initial credibility it so desperately
addition to Beryl W. Sprinkel, our IMM Boards(13) included
such distinguished names as Richard Lyng (currently serving as
U.S. Secretary of Agriculture); A. Robert Abboud, Vice Chairman,
First National Bank of Chicago; William J. McDonough, Executive
Vice President, First National Bank of Chicago; Robert Z. Aliber,
Associate Professor, University of Chicago; Henry Jarecki, Chairman,
Mocatta Metals, Inc.; and Fredrick W. Schantz, Vice President,
American National Bank and Trust Company of Chicago.
special significance were two officers of the CME: Everette B.
Harris, president of the exchange and Mark J. Powers, its chief
economist. Each of them, in their own way, were instrumental
in the IMM's ultimate success.
Harris had a vast store of accumulated futures expertise as well
as friends everywhere, thereby providing invaluable advice and
opening important doors to give us the needed opportunities to
preach the new gospel.
Powers, on the other hand, was a superb economist with a truly
fertile mind. He instinctively knew what the specifications of
the new currency and T-bill contracts should be; and, while those
specifications have been changed over time, they are still basically
traded the way Powers wrote them.
all these brave soldiers represented but a handful compared with
the armies who viewed the idea of financial futures with disdain.
It was to be an uphill struggle for many years to come. Fortunately,
its success depended more on world events and our tenacity than
on views of individuals or the odds against us. Listen, if you
will, to a candid appraisal of who we were and why we were so
were a bunch of guys who were hungry.
were traders to whom it did not matter-whether it was eggs
or gold, bellies or the British pound, turkeys or T-bills.
were babes in the woods, innocents, in a world we did not understand,
too dumb to be scared.
were audacious, brazen, raucous pioneers-too unworldly to know
we could not win.
the odds against us were too high;
That the banks would never trust us;
That the government would never let us;
That Chicago was the wrong place.
we were fast learners as well. While logic would dictate that
unsophisticated belly, cattle and hog traders could not long
survive the treacherous waters of foreign exchange when pitted
against seasoned forex specialists, the odds were shortened by
the simple fact that we were using our own money. That singular
difference spelled a trading discipline and a thirst for knowledge
that became a winning combination for those CME members who came
to the IMM's currency pits.
come they did, for they represented the quintessential ingredient.
Without traders who were willing to brave the dangers of the
new untested and illiquid markets, we could never have succeeded.
They came and stood there day after day, learning and shouting,
giving their time and money, infusing the initial liquidity that
ultimately lit the IMM torch.
we made some very smart moves, two of them decisive. The first
was that the new currency contracts were not simply added to
the contracts already traded at the CME. Rather, the IMM was
created as a separate entity with its own unique markets. This
structure allowed us to build a "financial futures" image somewhat
less encumbered by the history and impressions of age-old agricultural
importantly, it enabled us to sell memberships at a much lower
price to gain traders whose activities would be limited to the
contracts provided by the IMM. The new members were thus captive
of the currency pits, unable to participate in the more active
meat futures complex and forced to generate business in their
own arena. It was a crucial element in our growth and became
the model adopted by other exchanges when the financial futures
idea spread to our competitors.
second critical component at the outset was the so-called "Class
B" arbitrage device. It was a brand new approach to transaction-clearing
requiring us to be bold and imaginative.
the early days, the banks would not participate directly in our
markets. This meant that FX values at the IMM were not immediately
connected to the real world of the interbank market. To make
this connection, we created a separate class of clearing members
whose sole function was to act as arbitrageurs between a bank
of their choice and the IMM. The Class B firms were given special
margin accommodations while the banks who dealt with them were
provided unique security guarantees. It worked. And, although
Class B arbitrage was destined to become obsolete as soon as
the banks realized that dealing directly with the IMM was safe
and profitable, the system was essential until then.
is important to note that while, at the outset, the major money
center banks generally ignored the events in Chicago, the Chicago
banks did not. Their long-standing relationship with futures
markets was a profitable one and resulted in a futures expertise
within their walls. It, therefore, was easy for them to grasp
the concept of a futures market in currency.
is well that this was the case since we were in desperate need
of their assistance. Happily, the four major Chicago banks, Continental
Illinois National Bank & Trust Company of Chicago, First
National Bank of Chicago, Harris Bank and Trust Co. and American
National Bank & Trust Co. were very supportive of our IMM
the assistance of Continental, then the largest of the Chicago
banks and one with a world-wide network, was critical. Continental
agreed to act as the delivery agent for the new currency contracts
and helped devise a secure world system for this purpose. Without
a delivery mechanism, our contracts had no chance.
retrospect, in its formative period, the IMM made few mistakes—but
one of them was a whopper. The instant success of its T-bill
contract in 1976 made it clear to the world that the IMM's idea
represented a monumental new sphere of business activity. As
nothing before, this event served to enflame the fires of competition.
the IMM and its larger rival, the Chicago Board of Trade (CBOT),
searched frantically for the next new futures vehicle. It was
destined to be in the interest rate sector, but which instrument?
The IMM chose incorrectly to go after the middle range with a
4-year Treasury note contract; the CBOT, for the long range with
a 30-year Treasury bond contract. Long-term bond futures became
the most actively traded futures instrument, mostly to the credit
of Dr. Richard Sandor who spawned and championed the concept
for the CBOT.
there was a silver lining. The IMM gained an insurmountable hold
on the short-term interest rate sector that led it to capture
the Eurodollar contract. Today, this 90-day interest rate contract
represents the bellwether for international short-term interest
rates. It has become one of the most actively traded instruments
anywhere, and often maintains the largest open interest for any
futures were representative of still another IMM innovation,
one that dramatically expanded the boundaries of the original
concept. The IMM's notion to settle this futures contract in
terms of cash, rather than the traditional method of physical
delivery, was central to the future of futures. To the credit
of the CFTC, "cash settlement" was approved and paved the way
to uses never before thought possible for futures contracts.
Cash settlement became the gateway to the index markets.
befits but often escapes one who is first, the IMM ultimately
captured the lion's share of financial futures business as well
as the most diverse complement of financial instruments. Its
success catapulted its parent, the CME, from a lowly secondary
position in domestic markets, to a primary role in international
IMM served the CME in yet another dimension: it infused the institution
with a revolutionary spirit, spawning a heritage of innovation
and experimentation. This is a quality rarely found in major
financial organizations which, as a rule, opt for the safety
of "status quo."
heritage lives. The latest innovation of the Chicago Mercantile
Exchange is a direct descendant of the IMM revolution. On October
6, 1987, the CME membership overwhelmingly approved a joint undertaking
with Reuters Holdings PLC, the world's largest communications
organization, to create a global electronic automated transaction
P-M-T (Post Market Trade), it represents the first major attempt
to link all of the world's financial centers with a single futures
trading system, one which will utilize state-of-the-art technology,
operate virtually over the entire 24-hour trading day, and whose
transactions will be cleared by a single clearing entity.
bold and revolutionary concept is a comprehensive response to
the demands of globalization—a trend of world markets not lost
on CME officials. Indeed, the CME recognized that what Walter
Wriston, chairman of Citicorp/Citibank from 1970 to 1984, calls
the "information standard" is the dominant force of today's international
financial system. It is the result of the technological revolution
of the last twenty years, enabling information to travel at lightening
speed and creating a global marketplace—its trend and direction
irreversible. The Chicago Mercantile Exchange again was the first
major futures institution to accept this reality and react to
the IMM spirit has remained a permanent component of CME philosophy
and the critical element of its continued success. At the same
time, the IMM made financial futures an indispensable tool of
risk management and gained Professor Miller's coveted nomination.
And, while it is untrue that the IMM spawned flexible exchange
rates, there is no denying that our currency futures market is
inexorably intertwined with its occurrence. Indeed, we could
not have prospered nor would the world have fared as well if
the IMM had not been a necessary by-product of the same economics
that ushered in the new era of flexible exchange rates.
in The Merits of Flexible Exchange Rates: An Anthology
Innovation: The Last Twenty Years and the Next, Merton
H. Miller, Graduate School of Business, The University of
Chicago, Selected Paper Number 63, May 1986.
number of scholars have catalogued the events which signaled
the end of the fixed rate system. Events cited range from the
erratic monetary and fiscal policy in the United States produced
by the Vietnam War, the efforts of the Bank of England in 1964
and 1967 to prop up an overvalued currency, similar Bundesbank
efforts, increasing demand for U.S. gold reserves, the August
15, 1971 termination of the gold window by President Nixon,
the Smithsonian Agreement, the oil shocks. See: Alfred E. Eckes,
Jr., A Search for Solvency, "Death of Bretton Woods," pp.
237-271, 1975; W.M. Scammell, The International Economy
Since 1945, "The Breakup of the Dollar-Exchange System," pp.
179-201, 1983; Robert Solomon, The International Monetary
System, 1945-1976: An Insider's View, 1977.
No Such Thing as a Free Lunch, International Economic
Policy, Milton Friedman.
name stemmed from the place, the Smithsonian Institution in
Washington D.C., where, on December 17 and 18, 1971, the Group
of Ten ministers met in an attempt to resolve the international
system established by the EEC countries on April 24, 1972,
for the narrowing of the margins of fluctuation between EEC
currencies to 2.25% in a tunnel (plus or minus 2.25%). Original
participating countries included Belgium, France, Germany,
Italy, Luxembourg and the Netherlands.
International Monetary Market Annual Report, Message
from the Chairman, Leo Melamed.
International Monetary Market Annual Report, Message
from the Chairman, Leo Melamed.
Week, April 22, 1972.
Need for Futures Markets in Currencies, Milton Friedman,
1972, there was no federal law or agency from which we were
required to receive approval before listing a new futures contract.
The federal statute creating the Commodity Futures Trading
Commission (CFTC) was not adopted by Congress until 1974.
of the great ironies of this event was that, over our vehement
objections, the new agency adopted a rule requiring "proof of
economic justification," before a new futures contract would
be approved. It is doubtful whether in 1972 the IMM could have "proved" the
economic need for a futures market in foreign exchange. This
is a classic example of government meddling which results in
suppression of market innovation. Surely, only the marketplace
itself can "prove" economic justification of a financial product.
W. Sprinkel was named Chairman of the Council of Economic Advisors
by President Reagan on April 18, 1985. Prior to that, he served
as Under Secretary of the Treasury for Monetary Affairs from
April 1981 to April 1985.
first IMM Board of Directors included the following: Leo Melamed,
Chairman of the Board; John T. Geldermann, First Vice Chairman;
Carl E. Anderson, Second Vice Chairman, Robert J. O'Brien,
Secretary; Laurence M. Rosenberg, Treasurer; A. Robert Abboud;
Lloyd F. Arnold; Richard E. Boerke; William E. Goldstandt;
Henry G. Jarecki; Daniel R. Jesser; Marlowe King; Barry J.
Lind; Donald L. Minucciani; William C. Muno; Fredrick W. Schantz;
Beryl W. Sprinkel; Michael Weinberg, Jr.
remarks by Leo Melamed on the occasion of the Tenth Anniversary
Celebration of the IMM, June 4, 1982.
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