It's Good Enough for Milton"
By Leo Melamed
The Milton Friedman Commemoration
University of Chicago
January 29, 2007
Although I did not know it at the time, my first introduction to Milton Friedman occurred in 1940 when I was but seven years old. We were on the first leg of our escape from the Nazis at the outset of World War II and arrived from Bialystok, the city of my birth, to Vilna—that’s Vilnius, for those who don’t know the Yiddish name of this venerable Lithuanian city. My father, who was first and foremost a mathematics teacher, sat me down to provide my first lesson in economics. The circumstances made the moment historic and memorable. Years later, I had the privilege of relating this story to Milton and Rose.
In one hand my father held up a Polish zloty, in the other a Lithuanian lit. “Do you know what these are?” he asked?
“Money,” I answered, proud to show off my deep understanding of such matters.
“Yes,” he agreed. “And do you know how much each of them is worth?”
I shrugged my shoulders, having exhausted my expertise in high finance.
My father then carefully explained that the value of those two units of currency could only be determined by what they can buy in the marketplace. What followed was my first exposure to the logic of Milton Friedman. I learned that while the official rate of exchange between the zloty and the lit was one for one, in fact it would take two zlotys to buy a loaf of bread but only one lit. “The government’s official rate doesn’t mean a thing,” my father admonished.
It was the start of our two-year odyssey, as my parents with me at their side, miraculously outwitted the Gestapo and KGB in a danger filled escapade that spanned three continents, six languages, Japan, and happily concluded in the United States. The lessons in Milton Friedman’s free-market economics continued as we chased around the world, and as the lit changed to a ruble, the ruble to a yen, and finally a yen to a dollar. It left an indelible impression, one that resonated some thirty years later when I became chairman of the Chicago Mercantile exchange.
In 1970, the world was still chained to the failing fixed exchange rate regime agreed to in 1945 at Bretton Woods in the mountains of New Hampshire. Thereafter, foreign exchange trading was allowed only at the officially established rate of exchange. An individual, regardless of his standing, wealth, or businesses was barred from participation. In a well-publicized story, when Milton Friedman attempted to go short the British pound, a bank refused him the right to do so on the basis that “Friedman did not have the necessary commercial interest to deal in foreign exchange.”
As chairman of the CME, I was acutely aware that the idea of a futures market in currency, where everyone has sufficient commercial interest, was sheer heresy, akin to suggesting monotheism to a pagan. Knowledgeable people implored that the CME reject such a nonsensical idea. Most of our board of directors warned futures markets were suited for traditional agricultural products and little else. The orthodox financial community was also vehemently opposed. At best we were considered an “unwelcome” and very distant relative of the main-line financial family. Futures markets, they predicted, would never be utilized for the sophisticated needs of world banks and commercial enterprises. Besides, Chicago was the wrong place. That was the habitat of Al Capone. Matters of finance belonged in the holy centers of finance—London and New York.
It is nearly impossible today to understand or visualize the world before Milton Friedman’s ideas revolutionized the planet and became orthodoxy. What is self-evident today was heretical then. Much of the world was still suffering the pains of command economics. The Iron Curtain was still intact. The Berlin Wall had not yet fallen. The dollar did not freely fluctuate. “Free to Choose” had not yet become the roadmap for the international marketplace.
There was another overriding issue which plagued me then. How could I, a lawyer-turned-trader cum financial innovator really be certain that foreign currency instruments could succeed within the strictures designed for soybeans and eggs? Perhaps there was some fundamental economic reason why no one had before successfully applied financial instruments to futures? Indeed, on the eve of our currency launch, a prominent New York banker stated: "It's ludicrous to think that foreign exchange can be entrusted to a bunch of pork belly crapshooters.” Who could I turn to for advice? Who could overcome the weighty objections by so many? Who could give me courage to proceed?
For me there was but one person in the whole world capable of settling the issue. By 1970, I had become a committed and ardent disciple in the army that was forming around Milton Friedman’s ideas. He had become our hero, our teacher, our mentor. I even had the temerity to sneak into his lectures at the U of C, although I was not a student, to listen to the great man expound on the free market. What I heard made my spirits soar. Here was the voice of supreme economic authority saying that the system of fixed exchange rates was wrong. That it was time for its demise. Here was the fount of economic logic and vision saying that what I experienced as a child was true: That real value could be determined only by the free flow of supply and demand in an open competitive marketplace—perhaps, I mused, a marketplace like a futures exchange.
Suddenly, the inevitable came to pass—the stresses resulting from the dysfunctional fixed exchange rate system was more than the U.S. could bear. On August 15, 1971, President Nixon cancelled the U.S. dollar convertibility to gold. It was what Milton Friedman had advised Nixon to do from the beginning. For the world it unleashed a financial tsunami whose reverberations would be felt a decade later. For me it represented the moment of truth.
We met for lunch on Saturday, November 13, 1971, at the New York Waldorf Astoria.
I began by asking that he promise not to laugh. I held my breath as I put forth the idea of a futures market in foreign currency. The great man did not hesitate.
“It’s a wonderful idea,” he said emphatically. “You must do it!”
Elated, I pursued, “Is there any reason foreign currency might not work in futures markets?”
“None I can think of,” he replied.
For a moment his words hung in the air. When my voice returned, I said, “No one will believe you said that.” Milton chuckled, “Sure they will.” “No, I boldly said. I need it in writing.”
He smiled, “Are you suggesting that I write a paper on the need for a futures currency market?”
I nodded. “You know I am a capitalist?” Milton ventured.
We shook hands and settled on the amount of $5,000 for a feasibility study on “The Need for a Futures Market in Currencies.”
A friendship and bond was formed that lasted a lifetime.
Within a month, I held in my hand the Holy Grail for the Chicago Mercantile Exchange. The most influential economic mind of the 20th century provided the CME with the intellectual foundation upon which to build its financial futures super-structure. He said all he needed to in 11 pages.
The rest, as they say, is history. On May 16, 1972, the International Monetary Market (IMM), the financial division established by the CME for the exclusive trade in instruments of finance, ushered in the modern era of financial derivatives. Coincidentally, the following year, the Black-Scholes model provided the foundation for exchange-traded equity options. Both events occurred in Chicago. During the first decade of its existence, the IMM initiated a series of innovations in foreign exchange, interest rates, and equity indices. In 1986, precisely 14 years after its inception, Nobel Laureate in economics, Merton H. Miller, declared financial futures as "the most significant financial innovation of the last twenty years."
Sure we were lucky. Sure our timing was great. Sure the idea was invincible. But the major difference was the paper written by Milton Friedman. It was the equivalent to an unvanquishable secret weapon. With it in hand, we crisscrossed the nation innumerable times, visited every nation on the planet, addressed audiences large and small, faced government officials, bank presidents, corporate treasurers, and the brokerage community and convinced them that a market in currency futures—a market in financial instruments—was an idea whose time had come.
It was magical. For when we said the IMM was a great idea, the world yawned or laughed. When we told them Milton Friedman said so, the world took notice. When we were told, fixed exchange rates were coming back, we responded, Friedman said they are not! When we were told, Chicago is the wrong place, we responded: Friedman is a Chicagoan! When we were told that we were crazy, we responded: Friedman is one of us! And each and every time his name made the difference!
Throughout the years, this magic escalated. As his “Capitalism and Freedom” became the watchword for economic philosophy, as his logic on behalf of individual choice, free markets, and personal responsibility gained adherents, as his beliefs in individual liberty infused freedom around the globe, his name assumed near mystical proportions.
Presidents, finance ministers, central bankers, businessmen who would otherwise not have given us the time of day, or allowed us near their door, because of his name, opened the door for us. In the winter of 1975, Alan Greenspan instantly embraced our next iteration, Treasury-bill futures. He had read Friedman’s currency paper. When the CFTC required U.S. Treasury approval for the T-bill contract, at my behest, Milton Friedman telephoned William Simon, the Secretary of Treasury. Our contract was approved the same day. Milton Friedman rang the opening bell in January of 1976.
But perhaps the reaction of George P. Shultz is emblematic of the value of Milton Friedman’s paper and tells the whole story. Shultz was the first American government official I visited after the launch of the IMM’s currency market. He had just been appointed Secretary of Treasury. Secretary Shultz had no way of knowing that this was my first visit to Washington DC or that my knees were shaking as I entered his imposing office. Wisely, I had sent Milton’s feasibility paper to the Secretary before I arrived. There was very little conversation between us. Shultz listened to my explanation, smiled, and with a wave of the hand said, “Listen, Mr. Melamed, if it’s good enough for Milton, it is good enough for me.”
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