FREE MARKET VICTORY

Presented at the Sixth Annual International Finance Symposium
London, England
November 8, 1990.

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At the end of October 1990, a group of officials from the CME and CBOT visited Moscow at the behest of the Soviet government in order to sign a commodity market cooperation agreement. While there, we had a first-hand opportunity to witness and assess the depth of the devastation that seventy years of Communist central planning has perpetrated on this nation and its people.

From Moscow, I traveled to London to attend the CME's annual International Finance Symposium and were provided a most appropriate opportunity to give a comprehensive report. As is indicative from our rhetoric, I was struck by the extent of the havoc Communist rule had perpetrated on the Soviet economy and the bleak prospects for its reconstruction.

At the time, my grave assessment was rather unique since there was little common knowledge of the true abysmal economic condition of the Soviet Union. My report carried two central themes: the collapse of communist rule was a clear victory for a market-driven economic order; and the problems faced by the Soviet Union were such that it might take a full generation to cure.

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Wrote Charles Dickens, "It was the best of times, it was the worst of times." Perhaps that can be said of the world at any time, but it is certainly applicable to the world of today. Wrote Victor Hugo, "An invasion of armies can be resisted, but not an idea whose time has come." Certainly history has provided us with many examples to prove this wisdom, but none better than what we have witnessed in recent days.

Clearly, the inexorable idea of freedom for people as well as for markets was an idea more powerful than all the armies behind the iron curtain or all the generals the Kremlin possessed. It has obliterated the once dreaded Berlin Wall and allowed the people of the Soviet Union—indeed the people of all of Eastern Europe—to rise and throw off the shackles of tyranny and the chains of a centrally-dictated economy. When at last the glorious idea that freedom must dictate the basic structure of human endeavor could no longer be suppressed, when at last the dam burst open, it happened with such ferocity and with such stunning speed, that no general nor army would have dared to stand in its way. And so, for the Soviet Union and Eastern Europe, it is a brave new world: a world from which more statues of Lenin vanish each day (including from City Hall in Moscow); a world in which the truth about empty stores, long lines, rotting wheat and potatoes, frustrated and desperate people, and collapsing roads and buildings can no longer be hidden nor tolerated.

Said U.S. Federal Reserve Board Chairman Alan Greenspan: "It is almost as if a great experiment was conducted beginning some 70 years before. The world was divided into two parts. In one part there would be a market-driven economy based on the free forces of supply and demand; on the other there would be a centrally planned economic order based on the edicts of government. Today we can compare the results. They are stunning. On one side, a standard of living unimaginable when the experiment began; on the other, economic bankruptcy."

And now, President Gorbachev, as a means of breathing life into his moribund economy has abandoned the bankrupt Communist order and explicitly embraced the idea of a market-driven economy inclusive of futures markets. "We must get down to creating a full-blooded domestic market," he told the Soviet Congress of the Peoples Deputies last spring. "...Price, supply and marketing reforms, changes in the way state orders are placed, and steps to create first commodity and then stock exchanges will become necessary in this respect."

What Mr. Gorbachev knows is that markets—particularly those of futures—are in their essence voting booths. The participants therein, in continually buying and selling contracts are in fact expressing their informed opinions as to the future price of some underlying commodity—be it a pork belly or an index of stocks. This invaluable price discovery mechanism in turn aids producers, processors, investors and a host of other economic players in determining where and how to allocate resources; i.e., what to plant, how much to produce, and where to invest. And that as a consequence of futures markets, hedging and price projection have aided national economies in leveling the extreme peaks of over-production and extreme valleys of undersupply—precisely the mechanisms that are so lacking and desperately needed in the Soviet Union. And Mr. Gorbachev also knows that the same attributes that served agriculture, were later transformed to serve finance when the Chicago Mercantile Exchange launched the IMM in 1972 and began trading futures contracts on foreign currency.

From this revolutionary concept stemmed a host of financial futures instruments that included government securities, bonds, Eurodollars, and finally stock index futures. The success of these markets propelled the futures and options industry to unparalleled greatness. In the last decade alone, U.S. volume in futures and options has skyrocketed from 76 million transactions in 1979 to a record 323 million in 1989. And our success became a model for the world, resulting in non-U.S. futures and options volume growth from virtually zero just five years ago to 180 million contracts last year. Some thirty exchanges are now situated in virtually every world financial center and now trade financial futures and options on futures. The London International Financial Futures Exchange (LIFFE) established in 1982 was the first. The MATIF (Marché à Tèrme International de France), founded in 1986, is today the leading exchange in Europe with a trading volume last year exceeding 26 million contracts, an increase of nearly 10 million contracts from 1988.

However, while futures markets are an essential component of a market-driven economic order, they are not magic. The leaders of the Soviet Union have the mistaken impression that there is a magic wand that can wipe out the sins of Stalin and all those who followed for so many decades and instantly grant them prosperity. That they need only establish some securities and futures exchanges and declare themselves in favor of a market-driven order and it will happen. The problems and troubles are much deeper than most of us in the West realize.

Several days ago, we (officials of the Chicago Mercantile Exchange and the Chicago Board of Trade) returned from Moscow where we signed a cooperation agreement with the City of Moscow, the Moscow Commodities Exchange, and the Federation of Russia to assist them in the process of creating a commodity exchange. While there, I had a first-hand opportunity to witness and assess the depth of the devastation that Communist rule of seventy years has perpetrated. To say the country is bankrupt is to misconstrue the actual desperation of the situation. Indeed, their economy has achieved a new meaning for the word bleak, and the problem may be generational. The Russian public has been inculcated totally disbelieve everything the government tells them, to distrust all public officials and institutions, to expect corruption and to live by its rule, to hoard, to steal in order to survive, to disrespect laws, to expect pain, suffering, hunger, depressed living conditions and even inhumanity. As a consequence, the Russian people have lost what in the West is known as the work ethic. In the Soviet Union there is a saying that explains it well: "They pretend to pay us, and we pretend to work." Malaise is now a national trait. "If we in America are dominated by the workaholic," says Hedrick Smith, the bureau chief of the New York Times and well known authority on the Soviet Union, "then the Soviet Union is mired in hard-to-motivate Type Bs."

In the Soviet Union, it all depends on who you are. There is nothing for the masses and everything for the privileged. Indeed, the country has been bled dry in favor of armaments and space programs with nothing remaining for the people. My guide confided that "Moscow is just like New York. In New York you can get anything for dollars. In Moscow, too."

Cynicism underlies the entire Russian infrastructure. Cheating and fakery is an accepted way of life. Little else is understood. You do as little as possible, one observer explained to me. Many workers, he said, come to work in order to sleep, having spent the night with friends and vodka. The same attitude pervades at the highest levels. Managers and local party officials constantly deceive higher-ups. In addition, decades of central planning and dependence on the state have obliterated most incentives in the average Russian. He is averse to risk and very conservative. If the average worker had a choice between the free market and a guaranteed salary, he is apt to choose the guarantee. Moreover, most citizens are envious of success, no matter how it is attained. There is something wrong with making it, with being better off, and with achieving a better standard of living than the next fellow.

Decades of Leninist indoctrination does not easily dissipate. For the great masses of Soviet people, Capitalism is still a dirty word. Millions of people distrust the market and fear being outsmarted by sharpies. They still feel a profit motive is immoral. Explains Mr. Smith, "In debates at the Supreme Soviet, the most passionate arguments involve accusations that the free market will enable speculators to get rich by exploiting the working class."

"Perestroika," says television commentator, Vladimir Pozner, "has to happen in the mind for it to work. People's outlooks have to change, and that happens as society changes." That will not come easy. A former New York Times correspondent summed it up succinctly, "In America, it is a sin to be a loser, but if there is one sin in the Soviet Union, it is being a winner." Indeed, there is a psychological intolerance toward those who make more money, no matter how honestly they earn it.

It is bound to be a painfully slow process. It cannot be decreed and no institutional market—not even one blessed by the Russian Pope as was the Moscow Commodities Exchange—will be the magic answer. And conditions will get much worse before they get better. By government estimates, roughly 3 million people were thrown out of work from 1985 to 1989, and approximately 15 million more jobs will be eliminated during the balance of this decade. More than 40 million citizens work in jobs at sub-standard income levels—even by Russian standards. Shops are empty, there is even a lack of bread. Prices at private farmers markets—the only places where food in quantity exists—have already increased 25 percent in the first nine months of this year. Spiralling inflation is inevitable, with the government itself hiking the price it pays for meat and other agricultural products by about 50 percent since October 1. And retail prices, it is estimated by Grigori Yavlisky, the Yeltsin advisor, could shoot up by 400 percent overnight.

There may be hunger and even famine in some parts of Russia. And there will be civil unrest. Indeed, many of the Republics wish to secede and that may certainly occur. No one can with certainty predict the outcome of the current revolution taking place now in what Churchill once called the Iron Curtain. According to the report by the Organization for Economic Cooperation and Development, not only have the credit ratings of all East European countries been downgraded by the world private markets during the past year as the risks inherent in the transition from centrally planned economic systems to market economies becomes evident, but the Soviet Union can probably no longer be viewed as an entity for investment opportunity, rather one must look to the separate republics.

My purpose in recounting the difficulties that lie ahead for the people of the Soviet Union is to prepare for the possibility that suddenly one day you may hear some in the Soviet Union say they want to return to the good old days of Communist rule; that it was better than this. It may indeed have been. But that is foolish and foolhardy since it was the old order that brought about this desperate result. The old order was without hope and could only get worse. Thus, while the journey to a market economy will be painful and long, at least they have taken that first step and at least there is certainty of a successful result at the ultimate goal.

If this then represents the worst of times for the Soviet Union, by any comparison, the rest of the world is living in nearly the best of times. New ideas—ones that no one can stop—continue to motivate those of us who live in the other part of the world where the experiment of Adam Smith, Milton Friedman, and Alan Greenspan proved so successful.

Technology, as it has throughout the history of mankind, is again dictating fundamental change in our social structure, reshaping both the political and economic landscape. Satellites capable of beaming news instantaneously, powerful computers that slide into briefcases with room to spare, and fiber optic cables that span both the Atlantic and Pacific oceans have changed the world for all time. Not to mention the Paris-London tunnel!

Imagine the difference in our two worlds. There I was in the Kremlin, with Russia's second most important official, trying to place a telephone call to the CME for the opening of the market. This was not possible—not from the hotel, not from the street, not from a brief case, not even from the Kremlin itself!

Yes, there are two worlds. And the task from our part of the world is to adapt the futures trading idea to this new technologically sophisticated and globalized world. Thus we developed GLOBEX, an automated, electronic trading system capable of operating around the clock. Although, the implementation of this system is still in the future, surely one of its most significant achievements has already occurred. Recently the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBOT) agreed to unify the CME's GLOBEX with the CBOT's Aurora electronic systems. While most industry observers bet against this possibility and said it would never happen, they underestimated the power of an idea whose time had come. The successful discussions with the CBOT culminated in an overwhelming referendum vote by the CBOT membership in favor of GLOBEX. The resulting single, unified, after-hours trading system is bound to become the standard for the world. This momentous occurrence is the result of the undeniable logic that a joint electronic system between our two exchanges will immeasurably benefit all our members, member firms, and the futures industry worldwide. Indeed, when GLOBEX becomes operational, with the combined volume of the CME, the CBOT and MATIF, it will automatically include over 50% of the world's financial futures and options business. Most importantly, however, we invite all the major exchanges to join us in this endeavor. It is of particular importance for this community that LIFFE become part of GLOBEX, since London is and will always remain a central hub of world finance. Ultimately, we envision linkage with all the other world markets—be they in Japan, Germany, Australia, Singapore, or elsewhere. At the final seminar in Moscow, we were confronted by a delegation from a nearby province that demanded we include them in GLOBEX because, they boasted, they already have a computer.

In our view, GLOBEX represents the logical extension of the financial futures revolution that began with currency futures. It is the only realistic response for efficiently and cost-effectively managing global risk. It represents the avant garde of the financial services arena and is the precursor of market systems that will serve every segment of the financial world.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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